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Meetinq of the Federal Open Market Cormnittee
December 18, 1990

A meeting of the Federal Open Market Committee was held in

the offices of the Board of Governors of the Federal Reserve System in
Washington, D.C., on Tuesday, December 18, 1990, at 9:00 a.m.
PRESENT: Mr . Greenspan, Chairman Mr. Corrigan, Vice Chairman Mr. Angel1 M r . Boehne Mr. Boykin Mr. Hoskins Mr. Kelley Mr. LaWare Mr. Mullins Ms. Seger M r . Stern Messrs. Black, Forrestal, Keehn, and Parry, Alternate
Members of the Federal Open Market Committee
Messrs. Guffey, Melzer, and Syron, Presidents of the
Federal Reserve Banks of Kansas City, St. Louis,
and Boston, respectively



M r . Gillum, Deputy Assistant Secretary
M r . Mattingly, General Counsel

. Bernard, Assistant Secretary

Kohn, Secretary and Economist

Mr. Prell, Economist
Mr. Truman, Economist

Messrs. J. Davis, R. Davis, Lang, Lindsey,
Promisel, Rolnick, Rosenblum, Siegman,
Simpson, and Stockton, Associate Economists

Mr. Sternlight, Manager for Domestic Operations,
System Open Market Account


M r . Coyne, Assistant to the Board, Board Of Governors M r . Ettin, Deputy Director, Division of Research and

Statistics, Board of Governors
Mr. Slifman, Associate Director, Division of Research

and Statistics, Board of Governors M s . Low, Open Market Secretariat Assistant, Division of Monetary Affairs, Board of Governors Messrs. Beebe, T. Davis, MS. Greene, Mr. Scheld, and Ms. Tschinkel, Senior Vice Presidents, Federal Reserve Banks of San Francisco, Kansas City, New York, Chicago, and Atlanta, respectively
Mr. McTeer, Senior Vice President, Baltimore Branch

Messrs. Goodfriend and McNees, Vice Presidents, Federal
Reserve Banks of Richmond and Boston, respectively
Messrs. Guentner and Thornton, Assistant Vice Presidents,
Federal Reserve Banks of New York and St. Louis,


Transcript of Federal Open Market Committee Meeting of
December 18. 1990
CHAIRMAN GREENSPAN. of the previous meeting?
Would somebody like to move the minutes





Without objection. Gretchen Greene.

Are there any questions for Gretchen?


MR. FORRESTAL. Gretchen, do you think the market continues
to anticipate further easing by the Fed? Is that the [unintelligible]
of the market?
MS. GREENE. I think the body of opinion does expect that.
The questions in the market’s mind are: How much and how fast?

MR. HOSKINS. You mentioned that negotiations to ratify the swaps are finished. My question is: Given the size of our current foreign exchange holdings, why do we need to ratify those levels?

MS. GREENE. These are the swap arrangements that: we have
with other central banks. which have a term of one-year and are
renewable every year. As a routine matter we renew them each year.
CHAIRMAN GREENSPAN. It was more than just Germany and Japan.

MR. TRUMAN. Yes. the action to renew them was endorsed by
the Committee at the last meeting.

MS. SEGER. Gretchen. I’ve always wanted to know how much of the activity in the foreign exchange market involves corporate positioning as opposed to traders who work for money center banks. I know that many multinational corporations are having to get involved with foreign exchange more and more as a byproduct of their real work. Do you have any sense of how that proportion would fall out?

MS. GREENE. That’s a very difficult question to answer. partly because we don’t have very good statistics and part:ly because the concept is hard to define. When we last conducted the turnover survey. in 1989. we did ask banks t o tell us what proportion of their total foreign exchange turnover was with customers. I’ve forgotten the number, but I believe it was somewhere between 5 and 10 percent. But that only goes so far, because it depends on every respondent identifying who was a customer and that would not necessarily be a corporate customer. Nonbank financial institutions could be customers also. The rest of the business that a bank does. although it’s reported as interbank business, may be in support of the customer’s business. For example, if I do a trade with a customer and then I wish to manage my position. that forces me to go into the interbank market to do a certain amount o f transactions. I think the average



number of interbank transactions one might engage in to support one customer trade could be anywhere from 4 to 10. MS. SEGER. What made me think of it was that I was talking to a friend of mine who is a corporate treasurer and he was saying that in their shop, which is a very major company, they now have at least one person in the treasurer’s office 2 4 hours a day monitoring what is going on around the world not only because of general interest but also because of their foreign exchange situation. That’s what made me think that maybe corporations as whole, particularly multinational ones, are more involved than they used to be, say. 10 or 15 years ago. MS. GREENE. MS. SEGER. I think they are: the trend is definitely [up].
Thank you very much.
If not,

CHAIRMAN GREENSPAN. Further questions for Gretchen? can we hear from the domestic Desk, Peter?.
MR. STERNLIGHT. [Statement--see Appendix.]

CXAIRMAN GREENSPAN. Questions for Peter on either the Desk
operations or the leeway request?
MS. SEGER. You mentioned the reserves that institutions would need for clearing purposes and that, obviously. the required reserves also have served that purpose to this point. MR. STERNLIGHT. Yes.
MS. SEGER. Who actually will be determining that number? that a bank matter? It’s not a monetary policy matter.

MR. STERNLIGHT. Well, the banks will make their individual
decisions on this: it’s a question of what levels they will feel
comfortable with. We’ve spoken to some of the money center banks who
have been reviewing where they will be with the reduction in reserve
requirements. Several of them are considering establishing these
required clearing balances because they say, for example. that the
balances they would have to keep at the Fed would be coming down to a
range that just doesn’t give them enough of a margin of comfort for
daily operations.
MS. SEGER. Well. I understand that. But I just wondered if the people within the Federal Reserve who are so concerned about the daylight overdraft issue are also going to get involved in setting the numbers or if it would be driven strictly by managerial [decisions]. VICE CHAIRMAN CORRIGAN. Reserve Banks--

MR. STERNLIGHT. Well. the comments I’ve heard have had to do
more with just the avoidance of overnight overdrafts. Some of the
studies by the Board’s staff suggest that not very much impact is
expected on the daylight overdraft side of it.

MR. KOHN. We expect some increase. but relatively small. It is very hard to gauge, given that banks presumably would re-orient and



re-configure their transactions to avoid those overdrafts if possible.
In terms of required clearing balances. my understanding is that that
is driven primarily by the commercial banks in an effort to avoid
overnight: overdrafts.
MR. BOEHNE. Will we need to use foreign currency as backing
during this period?
MR. STERNLIGHT. It looks as though we will need to in early
January: I think Don would know.
MR. KOHN. Our projections agree with Peter’s.

MR. BOEHNE. Will there be some announcement of this or will
it just happen mechanically?
MR. KOHN. The Chairman signed a letter--Iasssume it went out last Friday or Monday--to the Hill notifying them and an S-letter notifying the [Reserve Banks]. Hopefully. there will not necessarily be a public announcement: it’s up to them. An S-letter should be already out or will be going out to the Reserve Banks with the appropriate documentation to the Federal Reserve agents. That was supposed to go out at the same time. s o it might have left yesterday. CHAIRMAN GREENSPAN. President Syron.

MR. SYRON. Peter, you mentioned market expectations of what
might happen next in terms of rates or even a discount rate move.

MR. SYRON. You noted what the situation was and the range of
expectations developing in the market. To what extent is that
difference due to this year-end situation? In other words. people are
saying that it may be a while before something happens: how much are
they influenced by the year-end situation? Is it markedly different
than if we were at the same place in the cycle--ifit’s possible to
determine that--and this were July rather than December?
MR. STERNLIGHT. I think the reserve requirement move was seen as being helpful in [terms of] the year-end situation. With respect to a further easing of reserve pressures or a reduction in the funds rate. I think some have felt that the steps taken recently helped in reducing some of those year-end pressures. But to say that that is a factor may just be imparting my own speculation about what their thinking process might be: maybe they’re looking forward to another move near term. A s I say. there was a high expectation, particularly after the last employment report. that there would be another easing by year-end: but it tended to get set back a little by the producer price report last Friday. MR. SYRON. Thank you.
MR. PARRY. I’m just wondering if the funds rate is going to
come down without a change in the discount rate. How do you think the
participants in the market would view that? Would that confuse them
or would that be a non-event?



MR. STERNLIGHT. There has been some discussion about whether
there are technical impediments to the funds rate coming down to the
level of the discount rate or perhaps even below the discount rate. I
think it would be feasible for that to occur--thatthe market would
accept it. They would probably continue to look for the discount rate
[cut] in due course. but they might think there were reasons--perhaps
concerns over the dollar or whatever--that the Fed was holding off for
a time on the discount rate.
MR. PARRY. Would it affect your operations at all?
MR. STERNLIGHT. It would take some careful implementation
whichever way one goes on this. So. yes. it would have some effect:
but I think it can be done either way.
MR. PARRY. Easier or more difficult?


I don’t really have a strong point of view.

MR. BLACK. It would be easier in that you would not have to
worry about what the level of borrowed reserves was as much as you

MS. SEGER. I have a question that relates to Bob Parry’s question involving the relationship between the discount rate and the fed funds rate and also the very low level of borrowing. It seems to me that a big part of the so-called reluctance of banks to borrow could be explained by that. If you can get fed funds for about the same rate as the discount rate why go through the hassle at the discount window? [Unintelligible] your favorite desk a call. We probably will see borrowing go to zip, if we let the fed funds rate and the discount rate coincide.
CHAIRMAN GREENSPAN. Except for those who pay big premiums
[over] the funds rate.
MS. SEGER. made money--
Yes. but I may know an atypical group that has

MR. SYRON. Would this have been seen as a possible temporary
change or do you think the market would interpret this as either a
change in operating procedures as far as what we said about the
borrowings or a ratification of a change that may or may not have
occurred in operating procedures? If we were to go effectively to no
difference [between the funds rate and] the discount rate or a penalty
discount rate without saying anything about-
MR. STERNLIGHT. I’m not sure how they would interpret it: I
think they might regard it as a temporary circumstance.
MR. KOHN. As I indicated in the Bluebook. I think that would
produce a little uncertainty. I agree completely with Peter that from
a technical perspective he could execute policy either way.
particularly now that we pay a lot more attention to the funds rate
and a lot less attention to borrowing than we used to. But I do think
putting the funds rate under the discount rate would raise a question



in some minds as to whether we had gone to a penalty discount rate. And it also would raise questions because the newspapers have reported that there are preferences within the Fed not to do that. So. I think if they see that. they then would be waiting for a discount rate change. It would raise a bit of uncertainty but it’s certainly completely doable from a technical perspective. It would perhaps lead to a small increase in federal funds rate volatility, but very small.

MR. KEEHN. Peter. I think maybe you have answered the question, but let me just go back over it again. On this year-end issue. I keep hearing that because of capital level constraints this year the year-end pressures are going to be particularly tough. Are you saying that was the case but [unintelligible] a bit?
MR. STERNLIGHT. Certainly. the concern is still there. It seemed to reach its peak about the end of November and came off. In the last couple of days we’ve seen some move back up but not with that near panicky feeling that seemed to be there in November. An awful lot of preparation was undertaken for year-end and in some cases we’re hearing that institutions have prepared themselves to be able, within limits, to take on some credits at year-end where they think they will find good business opportunities to do some of that. So. at this point anyway. I’m not looking at it as a terrible looming problem. but it’s certainly something that we’re going to keep a very close watch on right up to the year-end.

MR. GUFFEY. Peter, I don’t think I understand the Japanese [unintelligible] in the market that has pushed the rates up. Are [ U . S . money markets] providing liquidity to offshore Japanese banks or are they only providing liquidity to the Japanese banks here in the
United States?
MR. STERNLIGHT. Well, I think it has been provided mainly to the U.S. operations and then they may have done operations to move some of the funds. I can’t say what might have happened after that step. But as to why there was this greater sense of demand--maybe Ted or Gretchen would want to comment too--there was some greater reluctance among U.S. banks to extend lines to Japanese banks to the same extent as before, because even though U.S. banks were being downgraded and were regarded with less favor, so were Japanese banks. There was less willingness to extend some of those lines and less willingness particularly to serve as intermediaries between, let’s say. smaller U.S. banks that would have funds to provide and the ultimate Japanese bank as buyer. Whereas before a major U.S. bank might have been willing to sit there in the middle and take its 1116th or 118th. they might say that it’s not worth 1116th or 118th to have this exposure to an entity that’s coming under some question.
MR. HOSKINS. Peter. I think you alluded somewhat--maybe I
misread you--tothe idea that in your day-to-day operations it’s a
little more difficult to signal where we are. given the reserve
requirement change. I’m wondering if we should view this as an
opportunity to get a little more variability into the funds rate and
to get back toward more of a reserve borrowing approach. Of course,
that would require the discount rate to be moved if we were to choose
to operate in that way. Is this an opportunity?



MR. STERNLIGHT. I don’t really see it that way because I think what we have now just is a very low level of borrowing. And we don’t really have a good substitute to put in the place of the focus on the funds rate. If anything, as we go through this transition period in the reserve requirements. I think we’re going to have to lean even more on the funds rate. I really just don’t see a good alternative to that. MR. HOSKINS. Maybe we ought to signal explicitly then and
tell the market what the funds rate [objective] is.
MR. STERNLIGHT. Well. it’s coming darn close to that.
CHAIRMAN GREENSPAN. Further questions for Peter? If not, we
need two motions. I’ll first entertain the motion for ratifying the
Desk operations since the last meeting.

move. Is there a second?



CHAIRMAN GREENSPAN. Without objection. Secondly. would
somebody like to move Peter’s request for a leeway increase?
MS. SEGER. I’ll move that also.


CHAIRMAN GREENSPAN. Without objection. We’ll now move on to
the other regular staff reports. Messrs. Prell and Truman have the
MR. PRELL. MR. TRUMAN. [Statement--seeAppendix.]


MR. PARRY. Ted, I’d like to follow up a bit on your comments about net exports. The decline in GNP for the fourth quarter that the staff has in the Greenbook is about $32 - $33 billion and the improvement in net exports is about $30 billion. That improvement has to look highly unlikely. given the October number. You usually don’t have reversals, though this could be something of an aberration. MR. TRUMAN. Well, it could be. You may have noticed that last year we had a similar aberration in October. so I think there are some misplaced seasonal factors at work in these data. Obviously, if we had to go back and do the forecast given the data we have as of this morning, we might have a somewhat smaller swing. However, much of this swing is coming from the oil phenomenon and we have pretty good data going through the early part of December on that. I might note that the oil number that’s on the table there is higher than we had projected both in quantity and value, but that is largely because we found some oil in the New York harbor that hadn’t been included in previous months. If you strip that out. you have a sharp drop-off in



the quantity of oil. which will be stripped out in the GNP account, and a sharp drop-off in the volume of oil imports, which get valued at 1982 prices. S o . that’s going to have a big statistical impact in the current quarter. VICE CHAIRMAN CORRIGAN. Let me add: the oil was in ships!

MR. PARRY. If the improvement were on the order of maybe
half of what was forecast here, we could be talking about a decline of
1 or 2 percent more at an annual rate than the forecast.

MR. PRELL. We have not had time to sort through these data
in detail and to try to match them up against the various expenditure
categories, but I think one needs to emphasize that GNP measures
domestic production.
MR. PARRY. Right.
MR. PRELL. Indeed, as of last Wednesday when we went to press with the Greenbook. we didn’t even have retail sales data. etc. We were depending to a considerable extent on the labor market data to get some sense of what the input was to domestic production and then we were trying to make some reasonable guesses, in effect. about productivity and s o forth. But I think one should not leap to the conclusion that dollar-for-dollar any surprise in net exports would track through to GNP. We may find stronger expenditures on capital goods. for example, to match some imports or some other adjustment. There may be more luxury cars being imported, which will be part of our bulge in consumption in the fourth quarter. If that were the case, rather than coming out of inventories, that might have implications for the first quarter. So, I think it’s a very complex process that one needs to go through with these data. CHAIRMAN GREENSPAN. Well, can we assume that since the PCE
for October is higher than originally estimated and imports are higher
that we may be seeing nothing more than a higher level of imports of
consumer goods?
MR. TRUMAN. Every category was actually up: there is no one particular thing to point to. Automobiles were up substantially and that may be the luxury car phenomenon. Other consumer goods also were up substantially, but capital goods were up too. MR. PARRY. But you said PCE in October, right?
I’m sorry: I meant November.



CHAIRMAN GREENSPAN. Any further questions for the gentlemen?
If not, I think we’ll start around the table.
MR. BLACK. Mr. difficult times not only forecasters. This looks had before. I think the Chairman, these are obviously uncertain and
for consumers and producers but also for
a little different from anything we’ve ever
staff’s forecast is highly plausible, given



the assumptions on which it rests. But our hunch is that the
projection for real GNP for the current quarter and the first half of
1991 will turn out to be on the high side even if the oil prices do
come down from the relatively optimistic path that the staff has
assumed. I have several reasons for saying this. One is the big
revision the staff has made in net exports of goods and services by
showing a pretty steep, near-term drop in imports which, of course,
has the effect of raising both real GNP and net imports of goods and
services compared to the November Greenbook forecast. We think the
direction of this revision was clearly appropriate, given the weakness in domestic demand that’s been evident in the recent data and also the census data mentioned in the Greenbook and again the figures that
we’ve gotten on the merchandise trade balance for October--though a
lot of that may wash out as Ted suggested. Despite all those things,
the magnitude of the revision looks a little big to us. And the
second reason is this persistent weakness in M2. which I don’t think
anybody really can explain satisfactorily. That continues to worry us a great deal. And finally, we’ve been impressed by the continued
strong negative tone of most of the anecdotal information that we’ve
been getting from all sorts of sources. One piece of information that struck me as particularly impressive came from the
who is in the
plastics business and makes parts for manufacturers all over the
country and sells them on a nationwide business. He called up
specifically to tell us that the bottom had fallen completely out of
his order book, which is something that he had not seen before.
CHAIRMAN GREENSPAN. That was as of when?

MR. BLACK. This had happened last month. Now, we feel
somewhat more comfortable with the staff’s inflation forecast than
with the projections on output and employment. The staff has revised
downward a little its projections for inflation for 1991 and 1992 from
the last Greenbook, and that strikes us as appropriate. But as I said
earlier. I really think the monetary restraint that we have put in
place over the last several years as a whole may well produce greater
long-term benefits on the inflation side than the staff has been
projecting even if this recession turns out--as I hope it will--tobe
as mild as they are projecting.

MR. BOYKIN. Well, Mr. Chairman, about the best that we can say about the Dallas District is that it’s pretty flat. This is what our statistical evidence is saying and it has been confirmed by our board of directors at our meeting last Thursday and by other anecdotal information that we’ve been getting lately. It is increasingly difficult to find a segment of our District economy that is doing well. Most of our contacts are mentioning either mild declines or slight gains. Manufacturing activity has been weak, particularly in electronics and defense-related industries. Construction activity has picked up slightly, but most of that pickup represents a completion of major petro-chemical projects begun about two years ago. Our retailers are telling us that the Christmas season has been slow, with merchandise not moving except at post-Christmas-typediscounts. Overall. the outlook for the District economy is for little o r no growth over the next few months.



With respect to the national picture, I certainly would not
take issue with Mike’s forecast, particularly since he added somewhere
along the line that the risks are certainly on the down side.
MR. PARRY. Mr. Chairman. the economy in the Twelfth District continues to be slow overall, with mixed pockets of activity across the region. The California economy, which accounts for about twothirds of the District’s employment, has slowed along with the nation. If we look at employment, what has happened since August is that employment is actually down slightly and our year-over-year employment growth remains about 1 1 2 point above the national average. Not surprisingly, the slowdown has been most pronounced in trade. construction, and manufacturing, with year-over-year declines in construction and manufacturing that are not that different from the rest of the nation. In the near term we expect that the state will continue to move along with the national pattern. If you look at the remainder of the District. however. there are some rather interesting developments. There are some effects of the national slowdown. but the District’s manufacturing employment outside of California is actually at the same level as a year earlier and construction and trade employment are up 4 . 3 and 3 . 6 percent, respectively. Residential real estate sales volumes are certainly down in California, Hawaii. and Washington but up in a fairly sizable way-­ believe it or not--inArizona, Utah. Idaho, and Nevada. Home prices continue to rise except in Seattle and the coastal California areas, which, of course. do represent a very substantial part of the District. The agricultural outlook. which is very important to us because in some measures it is the single largest industry in the District. is quite bright. The USDA points to particularly strong production and export performance for the region’s fruits, vegetables, and other specialty crops. If I may turn very briefly to the national outlook: In the current quarter we see real GNP declining at a rate of about 4 to 5 percent, which is a bit stronger falloff than projected in the Greenbook. I must admit that I can’t point to any particular quantifiable factor that would be causing that degree of weakness. It’s obvious, for example. that the oil shock is not enough to produce that kind of a falloff. Our best guess is that we’ll see a small rate of decline in the first quarter, similar to that in the Greenbook. followed by a pickup in the second half of the year much along the same lines as in the Greenbook. including improved exports. It does appear to us that the underlying inflation rate may have peaked and that with the unemployment rate on the rise we’re likely to see some moderate progress in that area over the next year or s o . Our projections for inflation. however. are somewhat higher than those in the Greenbook. Thank you. CHAIRMAN GREENSPAN. President Syron.

MR. SYRON. Thank you. Mr. Chairman. I had thought until
relatively recently that we were beginning to see some signs of a sort
of second derivative in New England--a turnaround to some potential
flattening. But I must say, given the beginning of a slowdown in the
national economy. that that’s probably not in the cards at this point.
We have seen some real evidence in the region of markets working in an



entirely favorable sense in terms of better price performance and better asset levels [unintelligible] in wage levels. As far as the District itself goes--and I don’t know what the implications of this are for the nation--retailing looks very, very soft. People are out: there is activity in the stores. but people are not buying. Promotions haven’t been that effective. and retailers say they don’t expect that people are going to be buying after the first of the year. This isn’t a case of delaying purchases: it’s a case of people just saying “I’m not going to buy very much more.” I talked to some people yesterday at major department stores who jndicated that it has been a very poor Christmas season thus far for their outlets, both locally and nationally. And consistent with that is what we see in credit card activity. We talked with some people at credit card unit and they said year-over-year the level of charges in New England is down 3 percent, compared to up slightly nationally. I don’t know what the national implications of this are, but certainly in New England an important factor has been the loss of paper wealth in [declining values of] housing. We’re beginning to do some work on this and very very crude estimates would indicate paper wealth reductions of $600 to $800 billion in the region’s real estate. That is very significant on a personal income of about $290 billion in terms of any sort of consumer consumption factor. I think housing construction in the area still has to go down a ways. As I said. we have seen some real improvement in prices, with some spec housing having declined 40 to 5 0 percent in price and land prices also having declined in some areas. MS. SEGER. That’s an improvement: down 40 to 50 percent?
MR. SYRON. Well, it’s an improvement because the price level was just so high that it wasn’t consistent with any long-term viable economic gain. VICE CHAIRMAN CORRIGAN. Because it stops being solvent on
some of the prices? Is that what you’re saying?
MR. SYRON. It just stops being solvent at those prices. I think that’s an important point: I’m glad you mentioned that. Actually, until recently the transaction level had improved a bit. but land prices had very significant changes, again involving speculation in developed lots, finished lots. In some cases we know of, transaction prices were down 112 and in a few cases 3 1 4 from the original asking price. We’re also seeing this in labor markets, where there has been a very dramatic improvement [in the availability of] marginal labor, if you will--for warehouse labor, McDonald’s labor, and that kind of thing. The banking situation has been pretty bleak and obviously is going to continue to be so for a while: some bad news seems likely after the first of the year. As far as the credit crunch goes, I think we h seen indications that some of the larger banks are attempting to improve their earnings as they go out to increase their willingness to lend. At this stage, that really hasn’t been translated very much into increased activity. given the concerns that are going on. Manufacturing is generally weak, with some exceptions. Some exports are doing fairly well as are some short-term defenserelated items, particularly missiles ordnance that has to be replaced. Capital spending looks quite weak to us. In talking to some people-­ and one has to remember that 1981-1982 was a fairly benign period relatively in New England--we hear them comparing the current period



to 1 9 7 4 - 1 9 7 5 . and they are saying that they are just going to wait a while before they do any spending and that survival is the most important thing. I think a good side of all of this is that it has brought an increased awareness of the excesses of the past. We hear from more and more people: “Let’s just get this over with as quickly as possible and go on to something in the future.” I agree with Bob Parry in terms of the forecast: what we look at internally suggests that the fourth quarter could be a little weaker than the Greenbook [forecast]. As far as the national economy goes, I think we may well face somewhat of a bimodal potential outcome. I personally find the Greenbook a feasible forecast, albeit with somewhat of a change in conditions--some modest further easing. However. I am concerned about some of the imponderables [such as] consumer confidence. Historically, if you look at the data. these periods of oil price run ups and then improvement have been associated with a real bounceback in consumer confidence. This may be different because of the issue of diminishing war fears. I don’t know that I think this will wash out. but the perceived decline in wealth nationwide that Gary mentioned, given what is going to happen to housing prices. may have an effect. On the exports side. there’s some concern about whether foreign economies, particularly that of Japan. will be as strong as we might hope. And given what’s happened to prices, I think housing nationally will be depressed for a while. So. even without a real problem in the financial sector. there are a number of factors that could tip us over to the other side--intothe second of the two modes. I think all this argues for taking out some modest insurance on where we’re going: I don’t think in any sense that it means one should panic. I think we have made, or are in the process of making, substantial improvement on prices. And the issue is to keep that improvement but at the same time be vigilant so that this doesn’t really tip over into something that none of us wants. Thank you. CHAIRMAN GREENSPAN. President Forrestal.
MR. FORRESTAL. Well, Mr. Chairman, conditions in the Sixth District continue to weaken with the exception of the energy and chemical areas, which seem to be doing fairly well. Most of the industries in the District are experiencing deteriorating conditions. We did a recent survey of retailers about their Christmas season sales. and they say that spending is not only weak but has fallen below what had been very modest expectations to begin with. And as other people have mentioned, the retailers are not really looking for any comeback after the first of the year. The good news, to the extent that it is good, is that inventories at least are under tight control at this point, which is consistent with the discussion in the Greenbook. We don’t have the base of export activity in the District that other parts of the country have and. therefore, manufacturing activity is not good and we won’t get the effect of greater export activity. As a result of that, we’ve seen in recent weeks a stream of announcements of layoffs and plant closings. That includes the banking industry and that. incidentally, is getting front page headlines--not only the condition of the financial institutions but the layoffs associated with it. The business and financial contacts that I talked to in recent weeks are universally gloomy, and that includes our directors. Most of them. I would say. think that this contraction is going to be a deep and lengthy one--deeper and longer



t h a n t h e s t a n d a r d f o r e c a s t s . Worries about t h e banking system, a s I s a i d . g e t d a i l y a t t e n t i o n , and r e c e n t p u b l i c i t y a b o u t t h e FDIC i s c e r t a i n l y a g g r a v a t i n g p e o p l e s ’ c o n c e r n s and n o t c o n t r i b u t i n g t o c o n f i d e n c e i n a n y g r e a t way. On t h e c r e d i t c r u n c h . t h e most r e c e n t t h i n g I h e a r d was a t a m e e t i n g I had w i t h a b o u t 1 4 o r 15 b u s i n e s s p e o p l e . The o n l y t h i n g t h e y wanted t o t a l k a b o u t was t h e l a c k of f i n a n c i n g . They s i m p l y c a n ’ t g e t f i n a n c i n g e v e n t h o u g h t h e y h a v e had a l o n g a s s o c i a t i o n w i t h t h e i r b a n k , and t h a t i s a s o u r c e of g r e a t c o n c e r n t o them. While t h e s i t u a t i o n i n t h e S i x t h D i s t r i c t d o e s n o t l o o k a t a l l good, o u r f o r e c a s t f o r t h e n a t i o n i s v e r y s i m i l a r t o t h e Greenbook b o t h w i t h r e s p e c t t o GNP and i n f l a t i o n : and o u r a s s u m p t i o n a b o u t t h e behavior of o i l p r i c e s i s very s i m i l a r a s well. Notwithstanding t h a t . I do t h i n k t h a t t h e r i s k s a r e on t h e down s i d e o f t h e f o r e c a s t and I ’ m very concerned about t h e stress i n t h e f i n a n c i a l system t h a t could v e r y w e l l r e s t r a i n a rebound i n a c t i v i t y . I ’ m a l s o c o n c e r n e d a b o u t t h e weakness i n t h e m o n e t a r y a g g r e g a t e s . Now. t h e r e a r e two o t h e r t h i n g s t h a t I would m e n t i o n , which a f f e c t my o u t l o o k f o r p o l i c y . B e c a u s e o f t h e c r e d i t c r u n c h and b e c a u s e o f t h e s i t u a t i o n a t f i n a n c i a l i n s t i t u t i o n s w e may n o t be g e t t i n g t h e same e f f e c t f r o m m o n e t a r y p o l i c y t h a t we o r d i n a r i l y would: i t may be damped. And t h a t may c a l l f o r a l i t t l e more a g g r e s s i v e policy response a t t h i s p a r t i c u l a r time. I t h i n k it would b e a v e r y b i g m i s t a k e f o r us t o d e a l w i t h t h e f i n a n c i a l p r o b l e m s of t h e b a n k i n g i n d u s t r y by e x e r c i s i n g g r e a t e r f o r b e a r a n c e : t h e way t o d e a l w i t h t h i s s i t u a t i o n a s w e l l a s t h e economy g e n e r a l l y i s t o h a v e a more a g g r e s s i v e monetary p o l i c y . I g u e s s I’ll h a v e a c h a n c e t o s a y a l i t t l e more a b o u t t h a t l a t e r .

President Stern.

MR. STERN. Thank y o u . Mr. Chairman. There’s n o t a l o t o f a d d i t i o n a l news t o b e s a i d a b o u t t h e D i s t r i c t economy: t h e r e h a s n ’ t been a l o t o f c h a n g e . I w i l l comment on a c o u p l e o f t h i n g s t h a t h a v e come up r e c e n t l y . I n t a l k i n g t o some o f t h e l a r g e firms i n t h e Twin C i t i e s . a good number o f them had a v e r y good 1 9 9 0 , p a r t i c u l a r l y t h o s e t h a t h a v e some s u b s t a n t i a l f o r e i g n e x p o s u r e o r a r e m a j o r e x p o r t e r s . D e s p i t e t h a t , t h e y a l m o s t u n i v e r s a l l y h a v e a good d e a l o f c o n c e r n a b o u t 1 9 9 1 . p a r t i c u l a r l y d o m e s t i c a l l y , of c o u r s e . One o f t h e r e a c t i o n s t h a t seems t o be o c c u r r i n g i s t h a t t h e y a r e s t r e t c h i n g o u t t h e i r s a l a r y p r o g r a m s . T h a t i s . t h e y ’ r e g o i n g t o go a h e a d i n J a n u a r y w i t h t h e normal k i n d o f s a l a r y programs t h a t t h e y ’ v e had i n p r e v i o u s y e a r s b u t a r e t e l l i n g employees t h a t t h o s e i n c r e a s e s w i l l l a s t f o r 15 t o 18 m o n t h s . T h a t ’ s s o m e t h i n g t h a t I . a t l e a s t . h a d n ’ t come a c r o s s u n t i l r e c e n t l y , and I t h i n k i t i s c l e a r l y b e c a u s e o f t h e i r c o n c e r n s a b o u t t h e economy and b u s i n e s s c o n d i t i o n s i n 1991. With r e g a r d t o h o l i d a y s a l e s i n t h e D i s t r i c t . I ’ m n o t h e a r i n g much i n t h e way of e u p h o r i a n o r t e r r i b l e gloom. S o . I assume t h a t t h i n g s a r e r a t h e r m e d i o c r e and t h a t ’ s a b o u t a l l t h a t c a n b e s a i d a b o u t i t .

With r e g a r d t o t h e n a t i o n a l economic o u t l o o k , I g e n e r a l l y a g r e e w i t h t h e s h a p e of t h e economic p e r f o r m a n c e a s e x p r e s s e d i n t h e Greenbook. a l t h o u g h I w i l l a d m i t t h a t I ’ m l e s s c o n f i d e n t t h a t t h e upturn i s going t o occur q u i t e a s quickly as envisioned i n t h a t document. T h e r e a r e a number o f i n t a n g i b l e s t o w o r r y a b o u t a t t h i s j u n c t u r e . it seems t o me. And I t h i n k , a s Dick Syron s u g g e s t e d , t h e



major wild card is real estate values. I just feel instinctively that
if those values continue to come down substantially and if that
becomes more pervasive around the country than it has heretofore, that
has to have a bigger effect on the economy.

MR. KEEHN. Thank you, Mr. Chairman. While in a comparative sense economic activity in the District has been stronger than the national economy. as I have commented at past meetings. I think there has been a clear downward shift both in senriment as well as in the underlying level of activity itself. Probably the greatest impact-­ and Mike can certainly comment on this--hasbeen in the auto sector. We’ve finally reached the point where these fleet sales have moved through the system. And that had kept both production and sales at a higher level than we would have expected over the last several months. Given that, I think sales levels probably will be down and will be more reflective of underlying consumer demand. A s a result. sales forecasts have been reduced. One manufacturer that I talked to has reduced its sales expectations for next year by about 1 million units --downto 13-1/2 million units. And even that is dependent on a pretty good improvement in the second half of the year. At this point the auto inventories are at pretty reasonable levels with days supply around the mid-80s. and that’s certainly better than was the case last year. Nonetheless. production schedules for the first quarter of next year are down substantially. And the manufacturers say the risk is clearly on the down side--that they probably will be reduced even further as we get into the quarter. All of this is backing up into the suppliers to the auto industry: they’ve seen very significant cutbacks in their orders. S o . the backup is beginning to be pretty pervasive both in Michigan and Indiana. which are heavy suppliers to the industry. Another swing factor has been the level of construction activity. We also have finally been hit by this. Commercial contract awards have all but stopped. At this point we have quite a number of projects that are still [some distance from their] completion dates. So. we’re going to have a lot of floor space coming on and. therefore, vacancy rates which already are beginning to climb certainly are going to be climbing even further. We’re going to have some cash flow problems developing in some of the developer areas. For home starts, our numbers are perhaps not off as much as the national numbers, but currently we*re seeing a downturn there as well. The volume of home sales this year is significantly lower than last year. In the good news category, in the agricultural sector the
production levels clearly were high. although the prices weren’t quite
as good as farmers would have liked. Farm incomes at the end of the
year are really in very good shape and I think the farm sector is in
pretty good balance. Many of the uncertainties that were bothering
them before are behind us. Farm equipment sales next year are
expected to be about level with this year. There are going to be some
layoffs in that sector to bring inventories into line. but the farm
outlook seems to be pretty good.
It is hard to get a fix on retail sales. particularly this
early in the season. My hunch is that the Christmas season will come
in better than a lot [unintelligible] would suggest. Clearly, the



pricing is bad. When I say that sales will be okay. I really mean that in a volume sense. I think pricing is going to be very tough and, therefore, the profit levels will be down. On the inflation front, excluding energy. I think the news is just okay. Competitive pressures out there are terribly heavy and. therefore, the pricing continues to be tough. The steel industry is a good example. They’re going to ship 8 4 or 85 million tons this year. which comparably is a pretty good year, but the pricing is really rough. As a consequence, companies are shipping a lot of metal but are not making as much money doing that. And certainly on the labor front there are no current excessive upward pressures. In a national context, our forecast is very consistent with
the staff forecast. at least in broad contour, We have some interim
quarterly differences, but I don’t think that’s particularly
significant. In my mind, the major uncertainty here is the financial
system. I can’t remember a time when there has been a bigger buildup
of pressures throughout the financial system. It’s awfully difficult
to measure the impact if something were to get loose on us here in a
kind of [destabilizing] way. And when we get into the policy
discussion. that would be a very important determinant, at least to my
mind, of how we should conduct policy.

M Y BOEHNE. I would say that the sentiment is increasingly pessimistic or if it’s not pessimistic. the level of concern is rising. Retailers are still hoping for a season-saving finish. They have a long weekend just before Christmas and there’s still some hope: but there has been so much price discounting that even if sales do pick up, their profit margins are going to be poor. Manufacturing has been weakening longer in our District than it has in the nation, s o it’s at a very low level. But a number of manufacturers are building into their 1991 plans some pickup for the second half of next year. There is extreme pessimism in construction for obvious reasons. Bankers are worried to scared, depending on how close they are to retirement. MR. HOSKINS.
Some may retire sooner than they expected!

MR. BOEHNE. The District’s unemployment rate, which had been below the nation’s, has caught up with the nation’s and I suspect will rise above it. And for the first time in a long time we now have areas in the District with unemployment rates of 7. 8 . and even 9 percent. The state and local fiscal situation is very serious, particularly in Philadelphia. but it is not limited to Philadelphia. Now that the state elections are over, I think the state of Pennsylvania will have to face up to a large deficit. New Jersey. which has had huge tax increases. still has a deficit. And a number of municipalities that probably won’t make %Mall Street Journal nonetheless are having very serious problems.
On the national economy: While the Greenbook forecast of a
relatively mild. short-lived recession is plausible. my guess is that
it’s wrong and that we will have a longer lasting and a more serious
recession. Even if one is optimistic about how the Middle East
situation will come out and about oil prices, I doubt very much
whether consumer spending will bounce back with the same amount of



vigor by spring as envisioned in the Greenbook. Consumers just feel chastened after a number of years of some fairly loose spending habits. And I think they’re going to remain cautious. Even if the optimistic assumptions on oil and the Middle East are realized, we still are going to have high and probably rising unemployment. The consumer still has these high debt burdens, and delinquencies are rising. Also, the worries about bank safety. which are all over the talk shows and in the newspapers. just weigh on people and I think they are going to weigh on people even more. So, my guess is that we’re going to see a fairly bearish consumer for longer than envisioned in the Greenbook. CHAIRMAN GREENSPAN. President Melzer.

MR. MELZER. Starting off with the District, in terms of the statistics we are still slowing. But even though manufacturing employment is going down. we’re still getting modest employment growth overall. I’d say the employment picture generally in the District is somewhat stronger than in the nation. In terms of nonresidential construction. over the last year we’re down about as much as the rest of the country. Housing has not been hit nearly as hard, but it is down. As far as anecdotal information goes, and I mentioned this on our recent telephone conference call, the sense I‘m getting from directors and others--and it was reinforced in some further discussions last week--is that things have not gotten materially worse in the last 30 days. As far as holiday sales g o , I think retailers in the District are expecting modest, or maybe somewhat larger, real declines in retail sales. But that generally was anticipated and I think inventory levels in general are in pretty good shape. One very bright spot is bank performance in the District. We have thirdquarter numbers in now: Returns on assets are still about 1 percent: returns on equity are greater than 12 percent: and nonperforming loans are unchanged from the prior quarter and the prior year. CHAIRMAN GREENSPAN. Can’t you create some contamination? [Laughter.I MR. MELZER. Probably the fourth quarter won’t look as good: I’d expect some deterioration. But again. it’s a much better picture than I think we see elsewhere. In terms of expansion o f credit, that generally has been sluggish over the last year in the District. On the national front, the one comment I would make is that we’ve had some concerns over the last couple of months--really since September, October. and November--about the slowdown in the monetary aggregates. I guess the way that one would conceptualize what is going on is that as demand for reserves has fallen our operating procedures of pegging the funds rate has really caused us to drag out reserves to maintain whatever the targeted funds rate was. I think there was evidence in. say, the early part of this 2-1/2 month period that we weren’t really keeping pace with declines in other short-term market rates. I don’t know to what extent we can rely on these spreads. but it’s something that I think is worth looking at. The main point I wanted to make in this connection is that with the steps that were taken in November, we really have not only caught up with the declines in market rates but actually have moved the funds rate ahead o f them. Just to cite a couple of examples: From the end of September to the end of October. the funds rate had only come down 9



b a s i s p o i n t s , w h e r e a s s h o r t r a t e s had come down on t h e o r d e r of 20 t o 30 b a s i s p o i n t s d e p e n d i n g on what i n s t r u m e n t w e l o o k e d a t : b u t f o r t h e p e r i o d a s w h o l e , f r o m t h e end o f September t h r o u g h t h e m i d d l e of December r o u g h l y , t h e f u n d s r a t e was down 1 0 0 b a s i s p o i n t s and t h e s e v e r y s h o r t - t e r m r a t e s were down r o u g h l y 30 t o 60 b a s i s p o i n t s . So, i f one w o r r i e d a b o u t our b e i n g o u t o f p o s i t i o n and n o t p r o v i d i n g a d e q u a t e r e s e r v e growth. t o t h e e x t e n t t h a t t h e s e i n t e r e s t r a t e s p r e a d s a r e some i n d i c a t o r we c e r t a i n l y h a v e c a u g h t up w i t h t h e m a r k e t movement and gone beyond t h a t . P e r h a p s t h a t g i v e s a somewhat more o p t i m i s t i c p e r s p e c t i v e i n t e r m s of what r e s e r v e s and money m i g h t d o down t h e road.

P r e s i d e n t Guffey.

MR. GUFFEY. Thank y o u . Mr. Chairman. I n t h e Tenth D i s t r i c t , i n c o n t r a s t t o s e v e r a l o t h e r D i s t r i c t s , we s t i l l have growth--though t o b e s u r e i t ’ s r a t h e r m o d e s t . But w e a l w a y s had modest g r o w t h , I t h i n k , r e l a t i v e t o t h e n a t i o n : t h i s t i m e we happen t o b e p o s i t i v e w h i l e t h e n a t i o n m i g h t b e n e g a t i v e . A l o t o f t h i s l a r g e l y comes from a v e r y good h a r v e s t . For v i r t u a l l y a l l o f t h e c r o p s grown w i t h i n t h e T e n t h D i s t r i c t , t h e h a r v e s t i s c o m p l e t e d . The e x c e p t i o n i s t h e c o t t o n c r o p down i n s o u t h e r n Oklahoma, which i s a n o u t s t a n d i n g c r o p a p p a r e n t l y , and t h e p r i c e s a r e v e r y h i g h f o r c o t t o n b e c a u s e of some reduced c r o p s i n o t h e r p a r t s o f t h e c o u n t r y . A l l i n a l l , t h e a g r i c u l t u r a l s e c t o r i s v e r y h e a l t h y . C a t t l e and hog p r i c e s r e m a i n v e r y s t r o n g . Wheat, c o r n , and o t h e r s m a l l g r a i n p r i c e s h a v e d i m i n i s h e d b e c a u s e of t h e l a r g e w o r l d o u t p u t i n a g r i c u l t u r a l p r o d u c t s . However, t h e r e i s some h o p e - - n o t e u p h o r i a - - t h a t w i t h t h e e x p o r t c r e d i t s t h a t h a v e j u s t r e c e n t l y been g r a n t e d t o t h e USSR t h a t e x p o r t s o f a g r i c u l t u r a l p r o d u c t s w i l l p i c k up and w i l l i m p a c t o u r p a r t o f t h e world.

On t h e e n e r g y s i d e . t h e r e h a s been some modest p i c k u p i n exploration d r i l l i n g . I ’ m not sure t h a t t h a t w i l l l a s t very long. F o r e x a m p l e , t h e r i g c o u n t i n t h e T e n t h D i s t r i c t went up m o d e s t l y f r o m 325 r i g s t o 3 3 6 r i g s i n t h e month j u s t p a s s e d . But t h e employment p i c k u p i n t h e e n e r g y s e c t o r p r o b a b l y i s r e l a t e d more t o t h e r e w o r k i n g o f o l d w e l l s t h a n it i s t o new d r i l l i n g o r e x p l o r a t i o n . T h a t i s , you c a n t a k e a w e l l t h a t may b e p r o d u c i n g 6 t o 1 0 o r 1 2 b a r r e l s a d a y , rework i t f o r $ 1 0 . 0 0 0 , and i n c r e a s e t h a t p r o d u c t i o n t o 1 8 o r 2 0 b a r r e l s a d a y : i t makes sense g i v e n t h e o i l p r i c e s c u r r e n t l y . R e t a i l s a l e s w i t h i n t h e D i s t r i c t , a s b e s t a s w e have been I ’ m t a l k i n g about t h e a b l e t o determine. a r e e s s e n t i a l l y f l a t . C h r i s t m a s s e a s o n . ex a u t o s . Autos a r e v e r y s o f t a s t h e y a r e a r o u n d t h e c o u n t r y . I m i g h t j u s t i n d i c a t e , however, t h a t t h e b e s t a n e c d o t a l evidence about the a g r i c u l t u r a l s e c t o r [arose a t ] our branch board m e e t i n g s : T h e r e was one r e p o r t t h a t new p i c k u p t r u c k s were a c t u a l l y b e i n g s o l d f o r c a s h . which i s s o m e t h i n g t h a t h a s n ’ t happened i n 6 t o 8 y e a r s i n t h e Tenth D i s t r i c t . A s f o r r e t a i l s a l e s being f l a t , t h e r e p o r t t h a t I r e c e i v e d most r e c e n t l y a b o u t t h e C h r i s t m a s s e a s o n n o t b e i n g v e r y s t r o n g [ i s p a r t l y r e l a t e d t o ] t h e v e r y warm w e a t h e r w e have h a d . R e t a i l e r s e x p e c t or a t l e a s t hope t h a t i n t h e l a s t seven d a y s - ­ and t h e r e i s a c o l d f r o n t coming t h r o u g h t h e M i d w e s t - - t h o s e s a l e s w i l l p i c k up and t h a t t h e C h r i s t m a s o r h o l i d a y s e a s o n w i l l i n d e e d t u r n o u t b e t t e r t h a n most p e o p l e e x p e c t e d , a t l e a s t i n o u r p a r t o f t h e c o u n t r y .

12/18/ 9 0


With regard to manufacturing, automobile assembly plants have
been closed down periodically because of cutbacks by the
manufacturers. and the extended holiday will continue well into the
first of the year for all of the auto plants within our District.
Construction is essentially flat. both commercial as well as
residential. There is some hope. particularly in the state of Kansas:
there is a very big highway project there as a result of this public
works project. The value of the nonbuilding contracts in that state
is well ahead of last year.
All in all. the Tenth District is doing fairly well. All the
major cities that are metropolitan areas have unemployment rates well
below the national rate. And there’s fairly good optimism--at least
based on comments of our board members, not only at the head office
but at each of the branch boards.
With regard to the national outlook, we differ a bit in our
view of that but the depth of the recession is not greatly different
from peak to trough than what is projected in the Greenbook. We have
had some concern, and our numbers would reflect it, that the recession
will be a little longer by one quarter. In other words, rather than
turning up in the second quarter of next year we would not expect to
see that uptick until the third quarter: and then the latter two
quarters of the year would be fairly close in the aggregate to what
the Greenbook projects. With regard to prices, in the Tenth District
we don’t see any price pressures and we don’t quarrel with the
projections in the Greenbook.

VICE CHAIRMAN CORRIGAN. Mr. Chairman, as far as the national
economy is concerned. I think Dick Syron made my point earlier. If I
had to put a forecast on a piece of paper, I’d probably put down one
that looks a lot like the one that Mike has put in the Greenbook.
Having said that, and for all the reasons that have been cited
earlier, I think the risks in the second quarter of 1991 and beyond
are probably on the south side of that forecast. Indeed, in looking
at Mike’s forecast, if we had an economy behaving in growth terms like
his forecast for the next seven quarters--while it may be cyclically
less than we’ve seen in the past--I’dconsider that terrific.
Basically, he has 2-112 percent growth throughout the balance of 1991
and 1992.
Let me say a brief word on the local economy, in the New York metropolitan area particularly. Keeping in mind that in manufacturing terms that is nowhere near as important as it once was. the fact of the matter is that it still has something like 10 or 12 percent of the nation’s population and in some industries such as real estate it’s disproportionately more important than even population would indicate. For the metropolitan area as a whole, it is clear that the white collar recession is still deepening. Some of this is the prominent headlines that you see on cutbacks in financial firms. But it’s not just that. Indeed, that white collar profile of the recessionary forces in the metropolitan area really is quite extraordinary in any kind of a historical perspective. We think the real estate situation still has a ways to go south. Again, the market measured in square footage terms is very, very large. You lose sight of the fact that lower Manhattan by itself has almost as much office space as the city



of Chicago. And when you look at the situation in the metropolitan area broadly defined, New York City itself probably is marginally okay in that vacancy rates are now in the area of 20 percent, which is high but not fatal. And there is not a whole lot of fresh new supply in the construction pipeline; there is some, but not tremendously large amounts. Rents, on the other hand, really have plummeted. If you look at prime midtown office space--I’mtalking about large chunks of space. say, 200,000 to 4 0 0 . 0 0 0 square feet. not little pockets of space--spacethat perhaps as recently as a year ago but certainly 18 months ago could have commanded $50 to $ 5 5 a foot. today they are lucky to get $30. It really is an extremely large change in a very, very short period of time. As I said. the only saving grace is that there aren’t that many truly large blocks of space even in the midtown market with the exception of three or four buildings that are being finished on 6th Avenue. The suburban real estate markets are worse than the New York City markets and that is true pretty much across the board, whether you’re talking about Long Island, Jersey, Westchester. or parts of Connecticut. We don’t have very good statistics in terms of how much space is sitting there. Most of these surveys. Coldwell Banker and the like, are pretty good for cities but not so good for suburban areas. Based on what developers are telling us and what our examiners see, we think the downside potential in the suburban community is still quite considerable. Ed Boehne touched on this in the context of Philadelphia and Pennsylvania, but we have basically the same kinds of pressures on the state and local fiscal side with all the implications either for higher taxes and/or lower spending at the state and local level. The New York City situation isn’t great at the moment: it doesn’t look anything like the way it looked in the mid-1970s. but it’s not good. And whether we’re talking about Connecticut or parts of Long Island, there are large prospective deficits in state and local government budgets pretty much across the board. Leaving the metropolitan situation alone for a moment. the general psychology of the situation, as reflected in attitudes of CEOs of major multi-national companies, is that it’s pretty lousy. Interestingly. in the face of Ted’s comments earlier, I don’t get the sense that the companies that are major exporters are quite as confident about the potential for volume growth in exports in 1991 as they were even three months ago. Now, they haven’t said so, but it’s not considered a [near certainty] as I think it was as recently as three months ago that they would continue to see volume growth in the area of 10 percent or 12 percent. As far as the Christmas retail season goes, the sense I get
from both the national retailers that are headquartered in New York
and even from some of the small businessmen we talk to is that “It
ain’t good.” It’s very soft. The only exception is in the very high
price end of the retail market in New York City, and that’s coming
from foreign buyers. I don’t know how this gets into trade statistics
and things like that--notthat it’s all that important in absolute
dollars--but the very high end of the retail market in New York City
is quite strong mainly because foreign buyers benefiting from the
exchange rate look upon New York as a shopping haven at the moment.
On the credit crunch, there too I think we still have a ways to go. We will talk about this later. but one particular manifestation of that--theway it seems to be at least at the moment spilling through into the money supply--is becoming a greater concern



to me. The silver lining behind the cloud of the credit crunch is
that there is now what I would describe as pervasive evidence of
significant rebuilding of pricing and margins taking place pretty much
across the board. Now, some of that has been facilitated by the
withdrawal of the Japanese banks from not only the direct lending
markets but the commitments and standby-type markets as well. But the
evidence I think is now pervasive that we are seeing a significant
rebuilding of pricing and margins: whether it can be sustained is
another question. But I mention that because it is quite clear to me
that there is some combination of margins and spreads and levels of
interest rates that will snap the credit crunch and snap it in a
constructive way. I’m not sure we’re there yet, but we may be getting
closer than we suspect, especially if this rebuilding of spreads and
margins proves to be somewhat durable.
There are a lot of uncertainties. But the combination. as
Gary and Dick and several others said earlier, of the real estate
sector and the vulnerabilities as they impact on the financial sector
are probably the biggest single source of uncertainty as I see it
right now. I’ve said this before but let me emphasize it again: There
is a natural tendency to focus commentary on financial concerns on the
banking system: but as I see it those problems are every bit as acute
in both cyclical and structural terms for the nonbank sectors of the
financial system as they are for the banking system. Indeed. just
yesterday we were looking at a broad cross section of data on the
insurance industry. top to bottom. And I will tell you. that is
pretty grim stuff, to put it mildly.
Just anecdotally on the real estate situation. I spent a morning last week with Bob Boykin and his Dallas directors and up until then I had been tending to convince myself that Texas had turned a corner. Maybe Houston has. but one of in the construction business was telling me that he thought there were 10 to 20 million square feet of newly constructed office space in the Dallas area that would be better off bulldozed. If you say $100 a square foot and take the midpoint of that estimate of 10 to 20 million, that’s $1-1/2 billion worth of new construction with no place to go. So, again. o f all the wild cards out there I think that real estate-­ as it reflects directly on the economy, along the lines of Gary’s comments, but also as it reflects on these problems on the financial side--isthe biggest single wild card. CHAIRMAN GREENSPAN. President Hoskins.

MR. HOSKINS. The District continues to perform better than the nation. Just as an example: For the year October-to-October, output in the state of Ohio was up 5 percent and in the nation it was up about 2 percent. The weakest link, as you might expect, is in autos right now. There is one exception: We have an announcement of a new auto plant in the Lexington area that is going to employ a number of people. The Lexington area is an abnormal situation: the unemployment rate there is 3.2 percent. But the unemployment rates around the District over the last three months average 5 . 5 percent in Ohio and 4 . 2 percent but rising in the Pittsburgh area. Economic activity is definitely weaker than it was last month but that weakness is not translated, at least by most participants that we surveyed. into a recession in the District. They’re apprehensive that one will develop there: they believe one is under way in the nation. But when



we t a l k a b o u t a s o f t e n i n g m a r k e t , w e t a l k a b o u t r e d u c i n g o v e r t i m e . And o t h e r t h a n i n a u t o s and c o n s t r u c t i o n , we h a v e n ’ t had m a j o r l a y o f f s i n t h e D i s t r i c t . So. i t ’ s s t i l l performing q u i t e w e l l . In fact. the c a p i t a l goods s i d e i s s t i l l d o i n g b e t t e r t h a n m a n u f a c t u r i n g o v e r a l l . b u t n o t q u i t e a s w e l l as it was b e f o r e . I t ’ s a l i t t l e more mixed now, b u t t h e r e a r e s t i l l some p o s i t i v e s i g n s . Heavy t r u c k s had t h e i r t h i r d b e s t month o f t h e y e a r . i n terms o f new o r d e r s . i n O c t o b e r . So t h e r e i s s t i l l a l i t t l e s t r e n g t h around t h e D i s t r i c t i n c a p i t a l goods. R e t a i l s a l e s a r e f l a t . a s everybody h a s i n d i c a t e d a l r e a d y . I n t e r m s of t h e n a t i o n a l o u t l o o k , I t h i n k we’d b e p r e t t y happy t o s e e M i k e ’ s f o r e c a s t come t r u e . I t h a s a d e c l i n i n g i n f l a t i o n r a t e . We’d l i k e t o s e e a l i t t l e more o f t h a t . I would s i m p l y l i k e t o f o c u s on t h e f a c t t h a t t h a t ’ s a r e l a t i v e l y s h o r t r e c e s s i o n h e h a s f o r e c a s t and t h a t w h a t e v e r i s c a u s i n g i t - - w h e t h e r you b e l i e v e i t ’ s o i l o r t h e c r e d i t c r u n c h - - n e i t h e r i s l a i d [ a t t h e f o o t o f ] monetary p o l i c y . And t h e k i n d o f d e c i s i o n we’re g o i n g t o make l a t e r t o d a y r e a l l y i s g o i n g t o have i t s i m p a c t a t t h e t i m e Mike h a s a s n a p b a c k i n t h e f o r e c a s t i n terms o f r e a l g r o w t h . S o . t h a t i s s o m e t h i n g t h a t w e o u g h t t o t h i n k c a r e f u l l y a b o u t i n t e r m s o f making o u r p o l i c y d e c i s i o n . I n t h e l o n g e r term I g u e s s Mike h a s 2 . 4 p e r c e n t g r o w t h . which i s c l o s e t o o u r p o t e n t i a l g r o w t h : b u t I would e x p e c t us t o s e e i n h i s f o o t n o t e s a n o t e t h a t o u r p o t e n t i a l may be somewhat l e s s now. W h a v e a l o t of e a s s e t p r i c e s t h a t a r e coming down. I t seems t o me t h a t t h o s e r e p r e s e n t some e x c e s s e s t h a t o c c u r r e d i n t h e p a s t and t h a t r e s o u r c e s h a v e t o f l o w o u t of t h o s e a r e a s . I d o n ’ t t h i n k t h e r e ’ s any way a r o u n d t h a t . W h a v e some d e f e n s e r e s t r u c t u r i n g t o do and o b v i o u s l y some e restructuring i n financial services. I t seems t o m e t h a t t h o s e t h i n g s . a l o n g w i t h t h e f a c t o r s t h a t Mike p o i n t e d o u t , a r g u e t h a t o u r p o t e n t i a l growth probably w i l l slow i n t h e f u t u r e . So. I d o n ’ t have t h e s e n s e t h a t a n y t h i n g i s f a l l i n g a p a r t on us a t t h e moment. Several o f you s u g g e s t e d a number o f r i s k s t h a t a r e o u t t h e r e , and I t h i n k t h o s e a r e a l w a y s t h e r e . What t h a t p o i n t s o u t t o us i s t h e s i z e of t h e e r r o r s a r o u n d t h e f o r e c a s t - - t h a t we a r e v e r y u n c e r t a i n a b o u t t h o s e . And when w e ’ r e u n c e r t a i n a b o u t them I t h i n k w e o u g h t t o p r o c e e d cautiously. If t h e r e i s a r e a s o n t o e a s e , i t seems t o m e i t h a s t o do w i t h t h e m o n e t a r y a g g r e g a t e s . About t h e b e s t w e c a n do i n terms o f managing t h e economy i s t o k e e p i n f l a t i o n low and l e t t h e economy t a k e c a r e of i t s e l f . T h a t means we’ve g o t t o w a t c h t h e a g g r e g a t e s .

Governor A n g e l l .

MR. ANGELL. I t h i n k l o o k i n g a t t h e M 2 growth i s a l w a y s a good p l a c e t o s t a r t . I t seems t o me t h a t t h e r e i s c l e a r l y a v e r y s i g n i f i c a n t downtrend o v e r a f o u r - y e a r p e r i o d i n t h e growth r a t e o f t h e m o n e t a r y a g g r e g a t e s . But s o f a r t h e r e h a s n o t been what you would c a l l a c l a s s i c a l m o n e t a r y s h o c k : t h a t i s , t h e r a t e o f growth a c t u a l l y h a s b e e n b r o u g h t down i n a v e r y g r a d u a l p a t t e r n . It is true that the r a t e o f growth o v e r 26 weeks i s now g e t t i n g c l o s e t o a l e v e l a t which I t h i n k anyone would b e c o n c e r n e d i f t h a t were t o c o n t i n u e t o weaken on a 26-week b a s i s . But I would j u s t n o t e t h a t i n 1987 and 1989 w e had a l m o s t i d e n t i c a l p e r i o d s o f weakness on a 26-week b a s i s . C l e a r l y . we o u g h t n o t i g n o r e what t h o s e m o n e t a r y a g g r e g a t e s a r e s a y i n g . But I would n o t e . a s Tom Melzer d i d t o a d e g r e e . t h a t t h e y i e l d c u r v e d o e s n ’ t r e a l l y s u g g e s t t h a t w e h a v e a m o n e t a r y t i g h t n e s s phenomenon t h a t ’ s b e i n g d r i v e n by t h e c e n t r a l bank: t h a t i s . t h e s l o w [money] growth i s n o t d r i v i n g s h o r t - t e r m r a t e s above money m a r k e t r a t e s . W e have j u s t t h e o p p o s i t e . The y i e l d c u r v e b a s i c a l l y shows t h a t t h e r e i s



quite a bit of monetary liquidity out there. The foreign exchange
market also I think shows considerable monetary easing: that is, the
transmission mechanism of monetary policy for the United States is
increasingly through the foreign exchange mechanism. Certainly we’ve
had a considerable, 15 percent decline, of the dollar against the G-10
currencies. That is a factor for domestic stimulus. Commodity prices
it seems to me are showing more money neutrality than they are
monetary restraint. That is. you have some fall-back in commodity
prices, but you don’t have the rate of deflation in commodity prices
that set in during the 1985-1986 era and that really became pervasive.
Of the factors that we have going for us. the two factors I’d like to mention that are difficult to judge are the phenomena of house prices and other real estate. Unfortunately, there’s no futures market for housing. But I think we ought to begin thinking about housing and other real estate more as if they were a commodity. because clearly what has been happening here is really [similar] to what happened in the agricultural depression of the mid-1980s. which was a rather short. sharp depression in agriculture. What we see happening is that the forward price is not rising as fast as it was expected to have been rising before, Now, if someone has a 10-year horizon and expects house prices to rise at a 10 percent annual rate, that would mean a $100,000 house would be worth $269,000 in 10 years. But if all of a sudden you think it will rise not at 10 percent but at a 5 percent rate, then instead of $269.000 you’re looking at $163,000 for the 10-year forward price. That means that the forward price has to come down about 37 to 40 percent. If the forward price comes down faster than long-term interest rates, then o f course the present value is also going to fall. But that doesn’t mean that housing inflation is gone: it just means an adjustment from a 10 percent housing inflation environment to a 5 percent housing inflation environment. What makes this so tricky is that houses have so much to do with household perceptions of wealth. Consequently, household saving behavior is certainly impacted. I think all of us understand that we’re seeing a long-cycle event in regard to attitudes here. The other area of uncertainty. it seems to me, relates to the fact that the U.S. economy is increasingly competitive in a global marketplace. The international competition just means that there will not be sustained profit margins in any industry such as there were in former times when there was less vigorous international competition. Now. the problem that concerns me here is the advent of failure and whether or not we might be falling into a turnaround in an expansion in an international economic order and we turn that into a protectionist world in which international trade stops growing. That event then, of course, could lead the world into a most precarious circumstance. In that regard I think we should be rather careful about policies that might cause the foreign exchange value o f the dollar to weaken further, which in some sense can be a very strong motivating factor in regard to protectionism elsewhere. We have enough protectionist forces in the United States. And when we start seeing these protectionist forces hit the European Economic Community. as I think is entirely possible where the foreign exchange value of the dollar is right now, it means that we’re going to crowd in there at a rate that they’re not going to like--notjust in agriculture but in other areas. So. that’s an uncertainty that causes me to think more than once.




Governor Seger.

MS. SEGER. Just so you’ll know, I’m crying not because of the outlook but because I have a virus in my eye. Last night when I was reviewing the staff forecast one more time I was reminded of something in my childhood. Although it was a long time ago I do remember a few things from it! My mother always read to me every night and I had a strong preference for stories that had “they lived happily ever after” kinds of endings. I feel the same way about the forecast. I really do love the ones that are positive. optimistic, and happy. So. I have no problem [with the forecast]. And that’s why I would remind you that at the beginning of the year, when we had the soft landing scenario which was marvelous because it accomplished all our goals with no pain, no strain. no sweat. that was terrific. But it sounded too good to be true and what I have discovered is that if things sound too good to be true there is often a problem. So while this forecast isn’t [unintelligible] scenario, it still isn’t a dismal forecast. I hope that what is in the Greenbook turns out to be right. But I’ll just mention some of the questions I have about the numbers. even though. as I said, I hope that Mike’s and his staff’s assumptions are on target rather than mine. First of all, I really sense that whatever it is we’re in
now--1 call it a recession--it’s going to be longer and more serious
than the Greenbook suggests. One thing I’m more concerned about is
consumption. As you know, I’ve been taking a more dismal view of the
auto industry for some months now, and I think that some of my
concerns are [now] rather evident to the public at large. And I don’t
see what is going to turn that around really quickly. Also, in the
consumption arena I am concerned about the nature of the layoffs that
we’re seeing around the country: it’s not just Joe on the line at the
Rouge, the blue collar types I used to assume would be laid off. But
that didn’t have the same impact as when the sales vice president of
some company who lives next door loses his job or a bank president
loses his job or in some states bureaucrats are being laid off. That
sends a different message and I think it’s having a big impact even on
the people who are still working.
Also. there is the deterioration in confidence. I’m from a
state where confidence is usually negative because the state’s economy is very cyclical, so I’m used to a lack of confidence and nervousness and all that. But I’ve never seen anything like what I’m seeing now. And I’m not confining my remarks to Michigan at all: it’s widespread and is impacting ordinary individuals who just have this feeling that something isn’t right. They don’t necessarily know what it Is that’s wrong, but they just feel uncomfortable. I know that it’s nice to assume that that’s a fallout from Saddam Hussein and the higher gasoline prices and the worries over availability of oil, bur: my sense is that if all those things were taken care of [unintelligible] this afternoon and whatever it takes to solve this problem were done. this would not go away completely. Also. you don’t hear much about it, but there is a real problem with the consumer debt load. I used to nag our researchers about looking at the consumer debt load and was told that the two sides of the balance sheet were okay--that the assets were building at the same time as the debt load was. so forget it. But it is a problem now, at least for a lot of individual consumers. And I think some of the delinquency and loan write-off data suggest that. In fact Sunday night I happened to have my TV on and one of the


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PB evangelists came on and his wife was announcing that in January they’re going to run some seminars for their parishioners to tell them how to get out of debt in 1 9 9 1 . Now, that says something to me: It has even become a moral issue!

Also. we are being hit by very much higher taxes in this country. I realize we’ve just seen a nickel a gallon increase on gasoline so far, but that budget deal has a lot more coming up. That may help the budget deficit, but I don’t think it’s going to be a positive for consumer behavior. And at various state levels, there are substantially higher tax hikes down the pike. We saw a lot of tax hikes in 1 9 9 0 and I believe we’re going to see still more in 1 9 9 1 because so many states and cities and other localities do have budgetary problems. So, I just feel very concerned that the consumption side is going to be weaker than we’re assuming. Housing has gone down rapidly. We’re now down again to where we were back in the 1 9 8 1 - 8 2 recession--depressionfor my part of the world. That’s where we are already. It seems to me that the s o called credit crunch has been especially tough in this arena: it has been centered on the home builder, not Mrs. Jones who needs to get a mortgage to buy a house. It’s the financing for the person who wants to build the darn thing. Again. I hope I’m not being too negative but I just don’t see what’s out there that’s going to turn that credit availability problem around really soon for those kinds of folks. If I’m right that that’s a big constraint. then I don’t know what’s going to turn this around. On exports, I would just repeat what Jerry said. In talking to people who actually export rather than to academic analysts. I think the opportunities for 1 9 9 1 look a little less robust. And when I think about the shape of the economies of some of our major trading partners such as Canada. which is already in a serious recession. it makes me agree with the folks who are in the business. Also. I realize we’re running a sort of war in the Middle East, but I think there are still some defense cuts coming through, which will have an impact on places like sunny California and have already had some effect in the Northeast. So, those are some of my concerns. And what I think is really unique this time, though--to borrow the term of my favorite peanut farmer--isthis general malaise that seems to exist throughout the land. It’s hitting individuals as consumers but also as businessmen and women. Personally. in my life time, I have never seen it that way. On the financial fragility issue. there is this drumbeat-. which unfortunately is coming out of Washington. D.C.--about the problems of the financial industry. If we could put a gag or a muzzle or something like that on some of these people so they would shut up. maybe this problem would be less severe. But we haven’t, and the awareness of this is just becoming a big problem and in turn is tied into the so-called credit crunch. And as I already have mentioned a number of times, there is the special situation in real estate. the deflation in real estate values. Unless you go back to the 1 9 3 0 s . I don’t think you will see anything like it. My good friend Wayne Angel1 in his comments used +5 and +10 percent figures: you’d get some exciting numbers if you used -15 percent. Thank you. CHAIRMAN GREENSPAN. Governor Mullins.


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MR. MULLINS. I was most impressed with Lee Hoskins’ report that in the middle of this environment they’re building auto plants in Lexington, Kentucky, which shows you the resiliency of the American people. You didn’t mention: Was it Toyota or Nissan? [Laughter.]


MR. MULLINS. Toyota. My view is generally in agreement with the staff’s forecast. Producers seem to have cut back almost in advance of the cut in consumer spending, keeping inventories lean. And I think that puts the economy in pretty good shape for a rebound in the spring. It may be a bumpy landing rather than a soft landing. I’m not quite so sure that consumer confidence. Humpty Dumpty, can be reassembled as quickly as it is in the Greenbook. The pessimism is still rampant: I think Martha’s correct on that. I got a call from a former student who is a partner in They just had a meeting of their national partners and the overwhelming view there was that we had entered a deep and long recession. That doesn’t seem to be entirely consistent with the somewhat better than expected retail sales data and orders data, so there’s still this gap. Perhaps it has just been a long time since people have seen a nationwide recession, so they don’t remember what it feels like and it’s pretty scary and they don’t know how to get through it. Still. I think there is the potential for this rebound. The stock market thinks there is: it doesn’t appear to be quite so pessimistic as the public. Indeed. if we have a resolution in the Gulf, if the bad news on financial institutions becomes old news. and if the banks start to go for the profit, I also believe there’s a potential for consumer purchases that have been deferred. The autos that people are driving are reaching very old ages in terms of the average for autos. People still aren’t going to buy in the current environment, but at some stage we might get a rebound. I think the real estate problems are more troubling and long-lasting in terms of the wealth impact of that reduction [in value]. I still speak from the perspective of a New England homeowner. We also have several sources of stimulus in place moving in our favor. The oil prices have started to come down and 1 hope they’ll continue: the dollar is down: there is monetary ease--long interest rates. not just the short rates, have come down fairly substantially over the fall. Financial fragility continues to be a concern. Publicity
about it seems to be unending in virtually all areas. Jerry mentioned
insurance companies: I would just mention one industry that has yet to
hit the news but conceivably could and that is the mutual fund
industry. If you look at junk bond mutual funds, high yield bond
mutual funds, they’ve done an extraordinarily good job of managing
through this collapse in the junk bond market. However, over the past
several months a number of them have allowed their redemptions to run
their cash reserves to precariously low levels. Given the illiquidity
in the market. if one of them should have to suspend redemptions. very
quickly I think all of them would be under pressure. They’re a tiny
part of the market. It’s not significant from an overall point of
view, but I think it would get publicity and perhaps have an impact on
other mutual funds--bond funds. money market funds, and the like. I
wouldn’t suggest that monetary policy can do anything about that,
although it would be nice to have liquidity and a lot of credit
availability in that case. But I do think there is a potential for a



series of negative surprises in the finance area, which does not bode
well for confidence.
More generally. though, the concern is: Who is going to finance this rebound? Where is the financing going to come from to fuel the rebound? If you look across the board, the non-RTC thrifts reported very large losses in the third quarter. Most of that was in the group that is targeted for RTC action. But even the good thrifts, it seems to me, about broke even. Insurance companies are under pressure due to asset quality, and they also have a great need next year to refinance a large volume of maturing GICs. guaranteed investment contracts. So they’re going to be under some pressure: it’s not clear they can expand lending. Finance companies have been taking up a lot of the slack and growing at a rapid pace. Business loans by finance companies started the year at about $ 2 5 0 billion and they’re closing in on $300 billion. That compares with $600 to $700 billion in business loans at commercial banks, so it’s still not too large. I wonder how long they can continue to grow and take up the slack at this pace. Commercial paper also took up some of the slack. Again. nonfinancial commercial paper is only about $150 billion, s o presumably they can’t take up all the slack. But commercial paper issuance. after growing rapidly in August, September. and October. collapsed in November presumably due to credit quality concerns as marginal credits decided to take down their back up lines from Japanese banks, which probably accounts for some of the fed funds anomalies in that period. I think there’s little evidence of a credit crunch for investment grade companies. You only have to look to the bond issuance in November, which was up very dramatically: but none of that involved below investment grade issues. One wonders who is going to finance the segment of the market that is below investment grade. Banks have been the traditional source. I thought that the bank credit supply conditions were likely to ease in January. The logic was that a lot of these banks want to show a good risk-based capital number on that year-end statement. and that is done by investing in mortgage-backed securities and governments, not loans. I thought that would tend to free up. And there is the point that Jerry mentioned: The fed funds rate has come down quite a bit without the prime changing. At some stage those competitive juices have to start flowing, and I thought it would happen pretty rapidly in the first part of the year. I’m a bit more pessimistic now for a number of reasons. First, I’m pessimistic in the sense of thinking that this credit supply [situation], including bank credit conditions, is likely to extend into the new year. There is a growing concern and publicity about the bank insurance fund. Now, it’s accepted that there will be some sort of recapitalization paid for by the industry. I think there will be a period of uncertainty and banks may continue to hold back until they see how that issue is resolved in terms of how much they’re going to have to pay and in what form they will have to pay. I also think the FDIC will start to resolve some of these institutions that it may have delayed until the new year. The Treasury report on banking reform when it comes out. probably in the first week of January, may well call for some fairly dramatic changes. which will result in a lot of debate in Congress. That again might be the type of thing a banker would look at and say: “I think maybe I’ll hold tight for a bit instead of moving out aggressively.” Obviously, we still can have some bad news in the fourth-quarter results on asset



writedowns at banks. And even an issue like mark-to-market for banks is going to be debated. I think, in the early part of next year. The proponents of mark-to-market will argue very loudly that banks are misrepresenting their assets and misleading investors. And those sorts of arguments are not the type that are likely to lead to increased confidence in the banking system. So. on balance, there may be some easing of the credit supply condition. but I don’t think we’re going to return to normalcy until a number of these issues--suchas the bank insurance fund and having some of these problem institutions resolved and off the street--are resolved, probably later in the spring. We can’t control a lot of those issues. We can’t take responsibility for junk bond funds. But we should have responsibility for money. I continue to be bothered by its anemic growth. We did have blips in M2 in August and September but the overall pattern continues to be one of slow growth. M2 growth was 3.2 percent in the second quarter of 1990, 3.1 percent in the third quarter of 1990, and I think we’re projecting about 2 percent in the fourth quarter. This is no monetary shock. but it is a squeeze I would say. So, while the real economy seems to be feeling its way--however depressed people are--throughthis downturn in a manner which in my opinion has the potential to produce a rebound, I do think the slow growth in money and credit is not good news in this environment and does not augur well for achieving that rebound in the spring. CHAIRMAN GREENSPAN. Governor LaWare.

MR. LAWARE. Mr. Chairman, one of the advantages of waiting until almost the end is that you could just say “Me too” because everything has pretty much been said. But I can’t resist the opportunity to make a comment or two about the Greenbook forecast. It seems to me that oil is the major wild card in that forecast. And I’m uncomfortable with the assumptions that either the situation is going to stabilize in the Middle East or get better, which would bring oil prices down and keep them down. That seems to be an important part of the recovery [forecast]. It might have been useful in this special case to have had an alternative forecast that might suggest what would happen if there were hostilities in the Middle East or if the Saudi production capacity had been damaged in some fashion which would create, for example. an oil price of $40 a barrel and keep it there for a while. I think that would significantly prolong the timing of the recovery. The other wild card, it seems to me, is the credit crunch, which I think except for the comments around the table has been dismissed rather casually. And yet we have in at least one part of the country a credit paralysis that is affecting the whole economy and shows no signs of reversal. And I think that serious impairment is spreading down the East coast. Bankers clearly are worried and scared and certainly are unwilling to lend in major parts of the country. And consumers are worried. And Messrs. Littan. Brumbaugh. and Seidman and the media are doing their best to raise that worry to the level of sheer terror. I think that terror relates to consumer attitudes toward banks and toward investment and spending and getting further in debt. And since we have such a consumer-driven economy, it’s hard for me to see a rapid upturn until those consumer attitudes have changed. My best guess would be that those consumer attitudes will not change significantly until the Middle East situation is settled one way or another and until the banking situation is



perceived as being stabilized. I think those are the underlying
concerns that are haunting consumers, and I don’t think those
attitudes are going to turn markedly more optimistic until those two
factors have been addressed.
CHAIRMAN GREENSPAN. Finally, Governor Kelley.

MR. KELLEY. Well, Mr. Chairman, I guess I’m the last leaf on the bush and there’s certainly very little left to be said about current conditions, as Governor LaWare just remarked. But I would like to try to resurrect a perspective that I first offered. probably a little prematurely, a year or s o ago as to the underlying longerterm thrust of what’s going on here. It seems to me that what we may be seeing is the first downturn in what may be a rather powerful and long-lived deflationary era--a sea change. if you will. I think there’s considerable evidence underlying that. On a worldwide basis almost all commodities are abundant: food, materials. heaven knows in this country built space. and labor. Capital can seek out low cost labor and is mobile enough to get there and put production in place on a low-cost basis. It seems that monetary policy has been under tight control for some time: there’s not too much of a problem in sight there. Hopefully, fiscal policy is turning around. Maybe the most important thing on an economy-wide basis in this country is that I think we‘ve gone from an era of creating debt. which was inflationary, to servicing debt, which is deflationary. And if there’s anything to all of this thesis, I think it can explain a lot of the financial problems and a l o t of the real estate problems that we see. And it may be manifesting itself in this long decline that we’re going through in corporate profits, where firms are being squeezed between the last of the upward thrust o f cost pressures and the inability to pass that through in the form of prices. I don’t think this is a done deal. There are a lot of things--monetary, economic, political, sociological--that could change this and abort it. But if this is true, it has implications for how we view everything. If this is true, we may have a stickier short-term situation--a little slower in the near term to come out of the recession. b u t a far more positive longer-term outlook as time goes along and we do come out. The converse of that would be if we’re in another episode of what we’ve seen before in the postwar era. If that turns out to be true, we could wind up with a quick, weak recovery and then fall back rather soon and be very disappointed. But if it becomes clear that this is a new era and a disinflationary one. I think the long-term perspective is really quite positive. But that does leave us with a near-term challenge: to facilitate the weaning o f the economy off of the inflation kick that it has been on for so long and to avoid the potential for deflation and serious contraction that that could lead to. Thank you.

CHAIRMAN GREENSPAN. Thank you. Why don’t we adjourn for
coffee and come back in 10 minutes.
[Coffee break]
MR. KOHN. [Statement--seeAppendix.]
Questions for Don?





MR. MELZER. Don, I n o t i c e d i n t h e money p r o j e c t i o n s i n t h e Bluebook t h a t t h e r e ’ s a v e r y d r a m a t i c d i f f e r e n c e when you g e t o u t t o F e b r u a r y and March b e t w e e n a l t e r n a t i v e s A and B . much more s o t h a n I t h i n k w e n o r m a l l y see. Do you want t o comment on t h a t ? MR. KOHN. W t r i e d t o s t i c k w i t h a b o u t a normal d i f f e r e n c e . e F i r s t , w e have a d i f f e r e n t base h e r e . W a r e meeting e a r l i e r i n t h e e month t h a n u s u a l . O r d i n a r i l y , we would have a December-to-March b a s e and we’d be m e e t i n g a r o u n d t h e end o f December o r e a r l y J a n u a r y . So p a r t l y , i t ’ s b e c a u s e we’re m e e t i n g a c o u p l e o f weeks e a r l i e r . A s i d e from t h a t . we d i d n ’ t d o a n y t h i n g s p e c i a l t o widen t h e d i f f e r e n c e . W e u s e d t h e u s u a l assumed e l a s t i c i t i e s . MR. MELZER. I j u s t c a n ’ t r e c a l l 2 and 3 p e r c e n t a g e p o i n t d i f f e r e n c e s i n t h e growth r a t e s between t h e s e v a r i o u s a l t e r n a t i v e s . It j u s t struck me. MR. KOHN. I t h i n k t h a t ’ s r o u g h l y i n l i n e w i t h what w e see a s t h e e l a s t i c i t i e s a f t e r t h r e e o r f o u r months. MR. MULLINS. What i n t e r e s t r a t e e l a s t i c i t i e s do w e assume f o r money demand, r o u g h l y s p e a k i n g ? MR. KOHN. I c a n g i v e you some numbers on what if t h e f u n d s r a t e c h a n g e s b y x b a s i s p o i n t s . t h a t k i n d of t h i n g .


MR. KOHN. A 50 b a s i s p o i n t d e c r e a s e i n t h e f u n d s r a t e - - n o w t h i s i s a q u a r t e r l y a v e r a g e , s o it w o n ’ t show up t h e way i t would i n t h e m o n t h l y n u m b e r s - - g e t s you a b o u t 3 1 4 p o i n t f o r t h e y e a r . b u t i t ’ s l o a d e d i n t o t h e f i r s t and p a r t i c u l a r l y t h e s e c o n d q u a r t e r s . S o 112 p o i n t on t h e f u n d s r a t e w i l l g e t you a b o u t . 0 9 b y t h e s e c o n d and t h i r d q u a r t e r s and t h e n it t e n d s t o d r o p o f f a f t e r a w h i l e .

I t ’ s f o u r times t h e q u a r t e r l y r a t e .

MR. KOHN. Dave j u s t handed me a n o t e : t h e e l a s t i c i t y a f t e r , s a y . f o u r o r f i v e months i s a b o u t . 0 8 o r .0 9.
MR. MULLINS. And e m p i r i c a l l y t h a t works v e r y w e l l . M y i m p r e s s i o n was t h a t t h e t h e o r e t i c a l models had much l o w e r e l a s t i c i t y .

MR. KOHN. W e l l , I t h i n k i n t h i s c a s e a l o t d e p e n d s on how t h e o f f e r i n g rates a d j u s t t o t h e market i n t e r e s t r a t e s . That adjustment d r i v e s t h i s a l o t : t h e e l a s t i c i t i e s a r e lower over t i m e because the o f f e r i n g r a t e s t h e n a d j u s t t o t h e market rates. So o v e r t i m e - - a f t e r a c o u p l e of y e a r s - - y o u g e t some v e r y low e l a s t i c i t i e s . But o u r a s s u m p t i o n h e r e i s t h a t t h e o f f e r i n g r a t e s , w h i l e a d j u s t i n g p e r h a p s f a s t e r t h a n w e would h a v e t h o u g h t a c o u p l e y e a r s a g o b e c a u s e t h e m a r k e t r a t e i s moving down and we presume t h e b a n k s d o n ’ t want [ t o a t t r a c t d e p o s i t s ] , would s t i l l a d j u s t s l u g g i s h l y .


MR. MULLINS. And i n t h e p a s t t h e model f i t t h e d a t a p r e t t y When d i d i t s t o p f i t t i n g t h e d a t a p r e t t y w e l l ?

MR. KOHN. About t h e s e c o n d q u a r t e r o f t h i s y e a r . Well, t h a t ’ s n o t q u i r e a f a i r r e s p o n s e . We’ve had l a r g e e r r o r s f r o m


- 29

quarter-to-quarter and even for a couple of quarters in a row. But in
terms of cumulative error, this year we’re going to have the largest
error we’ve had, even outside the sample period. by at: least a half

MR. HOSKINS. Don. to your surprise, I’m not going to ask you
where alternative C is today. I do have a question.
MS. SEGER. You must have been in the Christmas punch1
MR. HOSKINS. I started early. Martha. I do want to followup on a couple of questions that have already been raised. You have pretty rapid growth--accelerating growth--in January, February. and March. The quarter finishes at 7 . 6 percent. And I guess that’s really what David was [raising]. To press on: What happens in the next quarter? Do you expect us to go back to a 6 percent growth rate or 5 percent or lower? MR. KOHN. In terms of alternative A ?

MR. HOSKINS. Yes, if we adopted alternative A.
MR. KOHN. In the 6 to 7 percent range, I think. It would still be an increment from where it would have been otherwise. So I guess what we would have would be more like 7 percent. MR. HOSKINS. So, we’d have a pretty strong first half, at 6 percent or something like that? It seems to me we’d be giving up some of our gains-MR. KOHN. I think you could have that kind of growth. I’ll try to be a little clearer here. We are assuming that this upward shift in velocity continues--adownward shift in money demand--so we’re sort of going off a base. If we had alternative A. say. that will give us about 125 o r 150 basis points [since] this past summer. Before, we would have expected much more rapid growth by the second quarter of next year if it weren’t for this shift. Our models, in fact. are projecting growth of around 6 - 1 / 2 percent in the first quarter: instead we have 2 - 3 1 4 percent growth. So, we have that down by an increment. but that’s relative to the fourth quarter which is already coming down. So, we still get the trajectory going up. It just has a couple of percentage points shaved off what you would have expected before the second quarter. MR. HOSKINS. But instead. under alternative A it will be about 6 percent money growth for the first half of the year. or somewhere in that range. You have 5 percent in the first quarter and 7 percent in the second. CHAIRMAN GREENSPAN. We are a couple of weeks away and there is just no evidence that that has started yet. So. be careful with your forecast. MR. HOSKINS. Well, we’ve been concerned about the model
because, as you know, we put a lot of emphasis on M2. We did try
running a different version with no trend variable in it. What we put



in was a thrift share as an explanatory variable and that did get rid
of the drift in the model. It doesn’t make money grow any faster. but
it tries to get at the problem in a different way.
MR. KOHN. We’re trying a number of experiments using yield curve variables and things along that line to try to capture substitutions in and out of M2. Our expectation was to try to supply the Committee before the February meeting--well before the February Committee meeting. we hope--witha memorandum summarizing the various experiments we’ve been running to help to explain this number. A pure model forecast with alternative B in it has a 5 - 3 1 4 percent growth in the first quarter and then 4 - 3 1 4 percent in the second quarter. [One­ and-one-half percentage points of] the impetus [behind] that 5 - 3 1 4 percent is an interest rate effect; the interest rate decline we*ve had through the fourth quarter has its biggest effect in the first quarter in that model. CHAIRMAN GREENSPAN. President Black, first.

MR. BLACK. Mr. Chairman, I was just looking at the P’ model
shown in Chart 9 and, as I read that. it provides me with a pretty
good comfort level. Don, do you take much comfort in that?
MR. KOHN. The problem, President Black. is that it rests on
an assumption about what the equilibrium velocity level is. And I
think the discussion we just had--
MR. HOSKINS. Clarifies it.

MR. KOHN. Occasionally, we have some doubts about whether we
will return to V * or not at that--
MR. BLACK. stable.
MR. BLACK. That’s right.
We don’t know anything that contradicts
Well. in the long run it has been pretty darn

MR. KOHN. We’re beginning to accumulate a few quarters that tend to move it away. but so far we certainly don’t have any lmgxun evidence that it has moved away. If velocity were to return to its old pattern and if we were to get the same M2 growth--so that the Committee didn’t compensate by having more M2 growth as velocity shifted back--then you’d get this pattern of prices. MR. BOEHNE. If the discount rate were to go down by 112 point but the Committee only wanted the funds rate to go down 25 basis points, how difficult would it be to communicate that to the market, given the fact that we haven’t done this much in the past and given the normal churning that goes on at year-end? It might take a while for this to occur and we may find ourselves in a situation of having t o - - . I guess the miscommunication risk is what I’m driving at. MR. KOHN. Peter may want to answer this as well, but my
thought was that you really have two instruments for that. One is the
press release. If this were the decision of the Committee and the



Board separately arrived at [a decision to cut the discount rate1 but somehow coordinated that, we could hint--without necessarily saying the funds rate will only drop by 114 point--that it’s partly to catch up to previous decreases in market interesr rates. That would be a very broad hint and we could play with that wording to give the best possible clue in the press release. And I think it would only take a couple of operations by Mr. Sternlight thereafter to make it clear. If they dropped the funds rate further than the Committee wanted it to. all we have to do is bring in some reserves in a pretty aggressive way. Now, I think you’re right that the churning around year-end is a problem: and my view is that if we’re going to do something, we probably ought to do it in the next couple of days to get it out there and done with and then pretty well even keel it through this potentially difficult period around year-end. But I don’t see why it can’t be done in the next few days. MR. STERNLIGHT. I would agree that it can be conveyed. I
think something about like that move is what a number of people in the
market expect. That would also help in being able to convey [an
intention] like that.
MR. BLACK. If we did this, you don’t think it would provide
an undue degree of surprise, do you?
MR. BLACK. That’s the way I read it.
And what if we didn’t do anything? Would that

MR. HOSKINS. be a surprise?

MR. STERNLIGHT. I think people are looking for some action
but not necessarily immediately. If nothing were done going well into
January. let’s say. I think that would be an element of disappointment
to the market.
CHAIRMAN GREENSPAN. Wayne, you were first.
MR. ANGELL. Yes, Don, I just wanted to comment. Of course, the problem that occurs by the Federal Open Market Committee moving away from the borrowing targeting is that we thereby take away the separation between the discount rate decision, which is the Board of Governors decision with the recommendations o f the Reserve Bank boards as a factor. If the Federal Open Market Committee really were to choose a fed funds target precisely--if we said we want it to be 7 percent. say--thenunder those circumstances there is no monetary power left with the Board of Governors and Reserve Bank District boards as we’d normally see. As long as we maintain the charade of a borrowing targeting then that separation of function can still be there, it seems to me. That is, as long as we write the FOMC minutes based upon the charade of borrowing then the old practice can still be there. MR. HOSKINS. Are you recommending that?
MR. ANGELL. Well, I don’t want to get into a discussion about the discount rate. I can argue both sides o f that.





MR. ANGELL. But I do think in this discussion we ought to
recognize that it might be desirable--that is, the Committee and the
Board may wish to consider maintaining a policy that does not wipe out
this distinction we’ve historically used. And I would not be for that
kind of a change [unintelligiblel.

MR. SYRON. Peter. you made the point that you thought the
market might be expecting something like 1/2 point on the discount
rate and 25 basis points initially on the funds rate. I find that
overall approach fairly attractive. But I’d like to ask Gretchen: Is
that generally in the neighborhood of what’s expected in the exchange
markets as well?
MS. GREENE. I think it’s fair to say that in the exchange markets the distinction between the discount rate and the federal funds rate may not be quite as widely appreciated. The symbolic influence of the discount rate probably carries a greater weight in exchange markets than it does domestically simply because the exchange market looks at lots of central banks and the discount rate for so many central banks is an important policy instrument. So, it might take a little while for the exchange markets to come to the same interpretation as the domestic market of such an action. MR. SYRON. Would there be some comfort, if I can use that
term. to the exchange markets by what would be conveyed in the sort of
press release that Don talked about?
MS. GREENE. They do look at the press release and, sure.
anything that could be comforting in the press release would help.

MR. BOEHNE. Don, what do you think it would take to get the
prime rate to come down?
MR. KOHN. I don’t know. We had a grand debate when we were writing the Bluebook as to whether something like this would take the prime rate down. Most of us felt that come hell or high water banks probably wouldn’t do it before the first of January. I do think that another easing and something as symbolic as the discount rate might pry a few people loose even before year-end. A further easing in my mind would raise the odds to a very, very high level that the prime rate will come down after year-end. The issue is whether they might reduce it sometime in the next two weeks. The discount rate change might do [the trick] by focusing some attention on it. But I think it almost certainly--he says hesitatingly!--would happen at some point after the first of the year. It would still leave an unusually wide spread between funding costs. assuming CD rates came down pari passu with the funds rate. So their margins would still be wide. CHAIRMAN GREENSPAN. Roger.
MR. GUFFEY. As I remember your earlier comment, Peter, the
year-end positioning has almost run its course, is that right?



MR. STERNLIGHT. I think the intensity of pressures reached a
peak about the end of November and then subsided. We’ve seen some
increase in rates again in the last couple of days but--as I see it
anyway--without the same sense of stringency or near panic that seemed
to be there in late November. I wouldn’t want to say it has run its
course. I think we could still be in for some pressures that you’d
want to monitor and maybe deal with in some way.
MR. GUFFEY. Well, given that. my question is: How soon after
the first of the year would you see that unwinding being completed?
What I’m really driving at is whether to delay a discount rate action
and a reduction of the funds rate until after the first of the year.
which is two weeks, roughly. given the several days on which the
market would [not] operate in any event because of the holidays.
MR. STERNLIGHT. Well, in terms of what the market looks for.
I think one of the critical things will be the next employment report,
which I believe comes out January 3rd or quite early in January. If
that looks weak again and if they haven’t seen some [easing] by then,
they will look for it and be quite disappointed if they don’t see it.
Normally, you’d expect year-end pressures to unwind about a week after
the turn of the year. We do have the added complication of the
reserve requirement reduction and how banks respond to that and how we
respond to their response.
MR. GUFFEY. I guess I was suggesting that since the activity
has not been as intense this year as in past years it might unwind
more quickly after the first of year--in a shorter period of time.
MR. STERNLIGHT. I don’t have a particular sense of that.

CHAIRMAN GREENSPAN. Any further questions? If not, let me
get started and be fairly brief because I think that we’ve covered a
lot of ground this morning and put on the table most of the major
issues. I think it’s fairly clear at this stage that the type of
economic phenomenon we’re looking at is something without any parallel
in the post-World War I1 period. This is in a sense a balance sheet
suppression, the type we’ve all been mentidning. It’s really quite
interesting to see the process, which is essentially one in which
values continue to be under significant pressure. For example. we’re
now beginning to see the weakening of residential real estate prices
work its way into the CPI through the owners’ equivalent rent numbers,
which have finally flattened out. Earlier data suggested that these
numbers moved in parallel: they went out of line a bit earlier this
year, which is probably a statistical fluke. But it’s fairly clear
that we’re beginning to see a disinflationary process going on.
starting largely from the balance sheet structure of businesses as
well as the financial system. And I think that’s a major element that
is feeding into the basic price structure. We are looking at it
through the assets side and also as assets affect prices and prices
affect wages, reversing the usual type of pattern. We’re obviously
also seeing a significant weakening in the retail markets as a
consequence of a fairly dramatic decline in realized capital gains on
the sale of existing residences. which started to be weak in the
second quarter. And, although the data are very fragmentary, as we
move into the fourth quarter the level of existing home sales has to
be awfully low. I think a goodly part of the weakness in consumer
markets is not only consumer psychology but also a reduction of



purchasing power--quite similar to what President Syron was talking about with respect to New England, only on a much broader basis. The psychology issue is obviously becoming really quite pronounced. While one can argue that a substantial part is balance sheet related and asset related. the coincidence of the decline with the Persian Gulf crisis clearly has to be a considerable part of that. But it’s fairly apparent. irrespective of how one is looking at the pattern of economic activity as it works its way back between psychology and action, that we are seeing a seizing up of some forms of credit availability. And the intermediation that has been taken out of the system in large part because of the savings and loan shrinkage is not insubstantial at this stage. So, overall what is occurring. as a number of you have said and one can sense it, is that the fear [felt by1 banks and the fear of getting involved in the intermediation process are really putting a big suppression on things. I would suspect the 2 percentage point difference that Don is getting between the growth of M2 and that in his model may in fact reflect something we don’t measure--namely. the inclination of individuals to hold liquid deposits which in the previous calculations are all presumed to be risk free. The very substantial [volume of] noncompetitive tenders [in Treasury auctions] obviously in train this year is a mere
suggestion of that particular phenomenon.
Having said all of that, we have severe recessionary
pressures. But recessions always end. And while our basic
requirement as far as policy is concerned is to make certain that we
maintain adequate liquidity in the system, especially under conditions
such as those we are now experiencing, we also obviously have to look
at the other side of this. At some point we are going to come out of
this and we want to make reasonably certain that when we do we’re not
looking at a degree of liquidity in the system that brings with it
[higher] inflation rates and the next downturn much more quickly than is usual. So, I think that it’s apparent that we have a fairly difficult next six months ahead. I don’t think there’s any particular short-term policy uncertainty. My judgment and what I hear as the general consensus around here. if I read it correctly, is that the money supply has become extraordinarily restricted and that we’re looking at what is a very major credit contraction. The fact that the prime rate hasn’t moved is an indication of the extent of that. And I think there is an inclination to ease up a bit further here. I’m becoming more convinced as the days go by that. while the optimum policy would be to somehow bring the funds rate down and [to generate1 the associated credit with it until we get the economy in somewhat of a balanced growth position at which point [short-term rates1 could stay down. the chances of being able to implement that are becoming increasingly small. It’s just not credible that a central bank can’t print money: and the more we try to print it, in figurative terms. the more likely it is that at some point we’ll succeed beyond our wildest dreams. And while I would argue strongly that we have to get some downside policy cushion here. namely to make certain that we supply adequate credit into the system, I think we also have to be prepared for the fact that we may. and probably will. overdo it. At some point the equations will come out right and we are going to be required to start pulling back, probably earlier than we might be desirous of doing s o , So. I would not at this particular stage leave out the possibility that we may overdo it, but I would not be overly concerned about that provided we are aware sufficiently in advance that that’s what’s happening. The difference between where the credit aggregates,



the money supply. the monetary base--allthe various financial elements with which we interface--are at this moment and where inflationary concerns are I think is rather substantial. We have a long way to g o , so I’m not particularly concerned about it. The bottom line that I come out with is: As I think we implied, the discount rate is on the table [for Board consideration] tomorrow. Should the Board decide to reduce the rate in line with the vast majority of the recommendations of the Reserve Banks. then it strikes me that perhaps the partial accommodation of a 112 point reduction in the discount rate with a 114 point in the funds rate. bringing it from 7-114 percent to 7 percent. probably is at this stage the most sensible policy option. If the Board chooses not to reduce the discount rate, I would still argue in favor of moving the funds rate another 114 of a point to 7 percent under appropriate open market policies. And I would further suggest that having done that, we should remain asymmetric toward ease. Comments? MR. ANGELL. Mr. Chairman. I’m sympathetic to what you’re
saying. but I just want to be sure that we’re maintaining as best we
can the fine line. I wonder if you could accommodate that to mean
that we would be voting here for alternative B symmetric toward ease,
and then you as Chairman of the Committee would have some discretion
over the intermeeting period, particularly as you sat with the Board
of Governors in regard to the discount rate.
CHAIRMAN GREENSPAN. It could be done that way. What I’m
actually recommending is that the FOMC act independently to move. But
as I noted, it’s a technical question,
MR. ANGELL. Here again. I’m thinking that the way policy runs and has run over the last several years is that at some period of time the Federal Open Market Committee has the balance of power. That is, during periods in which interest rates are increasing, ordinarily the fed funds rate moves up as pressures are put on the fed funds rate. In a sense the Reserve Bank directors and the Board of Governors have a standby policy. And even [when the rate is] on the way down that’s also the case. Now, on the way up a point is reached where the distance between the fed funds rate and the discount rate gets s o wide that no one is willing to allow that kind of a subsidy, so then the balance swings to the Reserve Bank directors and the Board of Governors. And until someone convinces me otherwise. I would favor maintaining that [balance]. And I would favor the FOMC saying at this point in time that the direction of interest rates downward now largely rests with the boards of directors of the Reserve Banks and with the Board of Governors. In a sense it’s kind of a flip-flop. I think we ought to hear a debate on that question and see if there’s a better way to do it. CHAIRMAN GREENSPAN. Well, why don’t we quickly put that on
the table and let people comment. Bob Black first.
MR. BLACK. Mr. Chairman. you formulated exactly what I would have done. I just want to express the hope that the Board of Governors in its wisdom does what you suggested it might do tomorrow so that the net effect would be a 114 point change in the federal funds rate. If the Board does not act, then 114 point is all I would want to do at this point. I think a 112-point move would do things to the bond market and the foreign exchange market that we wouldn’t like very



much. That would be seen as throwing in the towel [on inflation] at this point. S o , I’m with you 100 percent on that. CHAIRMAN GREENSPAN. President Parry.
MR. PARRY. [Unintelligible]. I guess mainly because the
Greenbook is a bit more optimistic than I would be. I would like to
make two points, though. It seems to me that the process that we’ve
been going through in recent months does suggest that there is a high
likelihood that we will overshoot at some point. I feel as though we
have to have a view of the future that we have some confidence in. We
realize that there are rather substantial lags in terms of when these
policy changes will have an effect. And if we don’t do that. and we
react primarily to conditions as we see them appear in the statistics.
I think that there is a high likelihood we will overshoot. Secondly,
if that does occur and maybe even if it doesn’t--andthis is a paint
that you certainly alluded to--1 think we need to be prepared to
reverse our actions at some point rather promptly.

Do you have any views on Wayne Angell’s

I want to think about it.

MR. HOSKINS. I wanted to get a clarification from Governor Angell. Are you suggesting that we stay at 7 - 1 1 4 percent asymmetric toward ease and, not to prejudge what the Board will do, but suppose that it lowers the discount rate 50 basis points, that all of that will be passed through? Or is that just a signalling device? MR. ANGELL. No. I was suggesting that with our asymmetry toward ease we delegate to the Chairman the decision as to whether or not the full 50 points show through or only 25 show through. I’m just trying to keep it technical so that the FOMC is only talking about the so-called pressure or [existing] pressure between the fed funds rate and the discount rate. But in the intermeeting period, given the uncertainty in the FOMC about what the Board will do, the Chairman would have the discretionary authority. And if the Board chose not to move the discount rate. the Chairman then could go ahead and immediately move the fed funds rate by 25 basis points. So. I’m not talking about any difference in outcome in terms of what the Chairman is suggesting: I’m just talking about the technical manner. MR. SYRON. If the Board voted not to accept the
recommendation of the majority of the Reserve Banks, what would be the
expectation, if I can use that phrase, of what the Chairman would do?
MR. ANGELL. Well, I think the Chairman has made it clear
that he would expect to move the fed funds rate.
MR. SYRON. ease?
MR. BLACK. Which might or might not be used.
25 basis points now and maintain asymmetry toward

MR. SYRON. Oh. yes.



MR. ANGELL. I’m not talking about any change in outcome from
what the Chairman is proposing.
MR. HOSKINS. Let me finish off then. My preference would be
not to change: I could live with asymmetric language. But I would
agree with Governor Angell’s proposal: that is. if the Board is going
to change the discount rate. do it first and see what happens. Then
we would have the opportunity, if the foreign exchange markets reacted
badly to that, to sit for a while or to move forward. It seems to me
to give you more degrees of freedom. But my overall preference-.
CHAIRMAN GREENSPAN. We do have to have a press release with
a discount rate action. which does bind our hands with respect to that
MR. HOSKINS. No. I’m saying that [unintelligible] you’ve
lowered the discount rate. say, 50 basis points, but you don’t do
anything with respect to the funds rate until that reaction-­
CHAIRMAN GREENSPAN. But if you do that, the problem is that the normal market expectation would be a 50 basis point decline in the funds rate, which is more than I think we want to suggest. So, in the press release we’re going to have to say something to the effect that the expectation is for it to show through only partially in the funds rate. MR. ANGELL. Mr. Chairman, I think the FOMC ought to talk
about the distance between the fed funds rate and the discount rate,
and they ought to be advising us along with the boards of directors.
And I think the Board of Governors should decide this question.
MR. LAWARE. I’m not clear on why you think they must move in
lock step. There has been a disparate relationship as long as I can
remember between the discount rate and the fed funds rate. We’ve been
operating for two weeks at least at a 114 point [spread between the
two rates]. We operated at 300 basis points for a while. Why would
the assumption be that we would drop both by the same amount?
CHAIRMAN GREENSPAN. Because that’s in fact what we’ve been
MR. ANGELL. Any time we’ve moved the discount rate. except September 3 of 1987. we*ve moved the fed funds rate the same amount as the discount rate. MR. LAWARE. Well, I don’t know why we should feel our hands
are tied because of that.
MR. BLACK. I think we could put out a news release if we
decided this sort of thing.
CHAIRMAN GREENSPAN. Well, let me put it this way. Let’s
first get the policy down for which there seems to be very little
difference. And then we’ll worry about the means of implementation.
It will not be viewed differently in the market but it will affect how
the minutes read and how the implementation of the directive reads.
It won’t affect anything else, but let’s make certain that we get some



agreement on what we’re actually going to do and hold for a minute the
question of how that is technically implemented. Bob Forrestal.
MR. FORRESTAL. Well. Mr. Chairman, with respect to the
policy issue I start from the proposition that we’re in a contraction,
that the contraction is going to continue. and that the risk of a more
serious downturn is present. And the risk of that kind of a downturn
is one that I would not like to take at this point. I think it’s an
undue downward risk, and I would prefer that policy be contracyclical
at this point rather than procyclical. I think you put your finger on
a very important aspect of this downturn: the psychology. And the
psychology is universally bad. Although monetary policy can’t cure
all of the ills in the economy and certainly can’t deal with the
Middle East and so on, I do think it’s the only thing at this point-­
unless there is a solution to the Middle East situation--that is
really going to bolster the psychology. So. while we do have the risk
of overdoing it. I would be prepared to run that risk at this point.
My preference would be to move 50 basis points immediately: however.
if you wanted to do it in two steps with an asymmetric directive. I
wouldn’t have a great problem with that. If you did 50 basis points
immediately. I think that to some extent technically solves the
discount rate problem because the funds rate would be below the
discount rate and the market would be expecting some symmetry between
the two. My preference in terms of policy and implementation would be
to move 50 basis points [on the funds rate] and to drop the discount
rate as well.
VICE CHAIRMAN CORRIGAN. First of all, I support precisely the recommendation that you put on the table. That is, I hope the Board will move the discount rate 1 1 2 point, with the Committee trying to settle the funds rate in around 7 percent--1 have no question myself that Mr. Sternlight and his friends can engineer that even in the year-end environment--and maintain asymmetry in the directive. I know it’s late, but let me just make a couple of quick comments in terms of the policy setting. I think Martha made a good point before when she spoke about the soft landing. Everyone knew that was going to be a difficult exercise. The economy now seems to have tipped into a recession. But I think it’s important that we and others keep in mind that if indeed it is a recession. the causes of it seem to be [primarily] an autonomous shift in expectations growing in part out of
excesses of the past, of which the credit crunch is a symptom. and in
part from Saddam Hussein. Not to raise vestiges of the past. but in
his Per Jacobsson lecture Paul Volcker made the point that if there is
a recession, it’s not going to be monetary policy’s fault. And I
think that’s right. Moreover, if we can achieve an outcome like
Mike’s forecast. I don’t think it’s the end of the world by a long
shot. In addition. we can say now what we couldn’t say six months
ago: that there’s at least a strong [hint] or two that suggests that
the inflation outcome could be better than we thought six short months
ago. All in all, while no one likes a recession, I don’t consider the
outcome terrible by a long shot as long as we get something like
Mike’s forecast. And that’s where I do worry a bit. if not a lot,
about the money supply. No one is ever going to accuse me of being a
monetarist, but as I see it the money supply, total reserves. and
whatever. are all kind of in the red zone. And in those circumstances
I think the policy you’re suggesting is exactly right. Even with that



policy I’m by no means convinced that we are inevitably and
irreversibly destined to overdo it. I think we can squeeze through.
Just quickly on the point that Governor Angell raised, which I think goes well beyond how we communicate this particular change: I think Governor Angell is raising a more difficult question of the whole matter of the relationships between the Board of Governors and the boards of directors on the one hand and the Open Market Committee on the other. I must say, Wayne, that looked at over a very long period of time on both sides of the interest rate cycle, I for one think that those relationships are about right. And I would be most reluctant to change them. I might add, at the risk of seeming to prod a bit, that if one does care about the [monetary policy] role of directors and the Board of Governors it seems to me it’s a matter of logical extension that one should not be too crazy about a penalty discount rate. MR. ANGELL. I understand that and as I suggested, Jerry,
there’s another side of that issue. In regard to that relationship I
feel exactly as you do.
CHAIRMAN GREENSPAN. Well. it might not be a bad idea at some
point to have a sort of a fleshing out of this [unintelligible] issue
you’re raising. President Melzer.
MR. MELZER. I can accept your recommendation on the funds rate, Alan. I think it’s probably appropriate. I have a sense--asI expressed earlier and to use a phrase I heard elsewhere--that we’re getting ahead of the curve a little. I think we have brought the funds rate down faster than market rates, and I presume that that is going to show through to the aggregates. But this is responsive to the concern of the slow growth. I agree with you that we’re likely to overdo it. Unfortunately. I don’t have the same confidence that we’ll undo it. I say that simply because I sat here as recently as 1 9 8 6 and 1 9 8 7 as we looked at quarterly growth rates in M2 in excess of 10 percent and I have to tell you there are lot of asymmetric monetarists. That’s Lee’s phrase, but I think it’s very true. There were many people not at all worried about that [M2 growth] at that time. I hope I’m wrong, but I’m not-­ CHAIRMAN GREENSPAN. If P* is any sort of basic inference, we
are significantly better positioned than we were then.
MR. MELZER. that’s why-­
Oh, I understand what position we’re in. and

CHAIRMAN GREENSPAN. We have a lot of room to make a mistake
in here.

MR. BLACK. Bob Parry and I are going to be on next year too [as voting members] ! MR. MELZER. In any case, I would like to try to avoid the
overshooting not only for that reason but also because I think a
volatile monetary policy has other consequences that flow from that.
On the discount rate. if it were up to me I would let the 1/4 point



show through in open market operations tomorrow and I’d be inclined to cut the discount rate on Friday. And at that point I’d make it very clear that it’s simply a technical adjustment to move the discount rate in line with other rates. I think the communication in this other scheme could get a little confusing. I think we could establish a 7 percent funds rate by Friday and then just have a technical adjustment [in the discount rate1 and use the appropriate language for that. I’m not concerned about Wayne’s concern here. We could be left in the same position if the Board decided not to move the rate on Wednesday and then we would have a situation where. with the authority we are proposing to delegate to the Chairman, we would still have the funds rate coming down close to or possibly below the discount rate. So. I’m not troubled with that. I’d go ahead with the open market operations. CHAIRMAN GREENSPAN. President Keehn.
MR. KEEHN. Mr. Chairman, I would enthusiastically support
your recommendation, which I think is absolutely the right thing to do
given the current circumstances. Specifically, in terms of our
decision here today. I would reduce the fed funds rate by 25 basis
points, have asymmetric language. and hope that the discount rate
would be reduced concurrently or shortly.

I support your recommendation, Mr. Chairman.
President Boykin.


MR. BOYKIN. I would support your recommendation, Mr.
Chairman. I would also hope that there is a discount rate cut. The
only comment I would make is that I hope you would exercise
considerable discretion in going any further in the intermeeting
period unless something very unusual happens.
CHAIRMAN GREENSPAN. President Hoskins.

MR. HOSKINS. I just wanted to finish the policy statement
separate from the discount rate issue. I think we ought to have
asymmetric language. I’d rather have the 25 basis point move in the
hands of the Chairman at his discretion. We have made some
significant moves in terms of interest rates in the recent past and we
haven’t seen those fully show through yet. Don’s projections
presumably could err on both sides. not just one side, and we may well
get a faster growth rate of money. But even with the projection that
we have, a 50 basis point move puts us at the top of our tentative
target range for next year by June. And it seems to me that some
patience is needed here and some careful watching of the aggregates.
I’m not averse to moving if the aggregates pan out to be more than a
26-week fluke. But maybe we ought to see what’s in that aggregate box
before we move ahead.

MR. SYRON. Mr. Chairman. I like your suggestion exactly as it was put. I disagree with Lee in the sense that I think what the FOMC ought to do--I’mnot a voting member--is vote to make a 25 basis



point cut with asymmetric language toward ease. It is true that this
is not a policy-induced recession. I think that’s a very important
point. It is also our responsibility to take into consideration the
world as it exists, and I think what you suggested does that without
panic on the down side. I think it’s very important that we now move
ahead, but I must say I feel some of Tom Melzer’s concerns about how
quickly we’ll adjust, being a confessed asymmetric monetarist. We may
not react as quickly on the up side. It’s important that the FOMC
vote for what it thinks should be done, and I’m a little wary of
getting into things that have too many conditions. This is a very
difficult question. Besides the results of being on horseback here,
there are too many things that are permutations and combinations--that
if A happens we’ll do this and if B happens we’ll do that. We ought
to say what we think should be done, and I think your suggestion did

MS. SEGER. I enthusiastically support a move toward ease, and tomorrow I will vote in favor of a discount rate cut because I think one of the reasons for the lack of confidence in business communities is the feeling that somehow or other a lot of people in Washington don’t know what’s going on. I think this would be a kind of discreet action. It wouldn’t be so discreet that no one would know it, but it would be something that would fit on the front page of the newspapers and, therefore, would be communicated all over the country and not just to fed watchers. And that would help a great deal. I’m not a betting woman, but to answer Don Kohn’s question: If this goes across the wire tomorrow at 9 : 3 0 a.m.. we’ll see the prime rate cut announcements starting about 9 : 4 2 a.m. MR. SYRON. That’s pretty precise!
SPEAKER(?). You want to bet?

MR. BOEHNE. I support your recommendation, Mr. Chairman. I think the Federal Open Market Committee ought to vote for a 1 / 4 point reduction in the rate today with an asymmetrical directive, and I think you and your colleagues ought to do what you will tomorrow. CHAIRMAN GREENSPAN. As long as it’s the right thing!
Governor LaWare.
MR. LAWARE. I support your recommendation, Mr. Chairman. The only thing I’d add is that I feel quite strongly that under the circumstances there is very little chance that this particular policy directive would lead us to overshoot the mark. right. CHAIRMAN GREENSPAN. Governor Kelley.
MR. KELLEY. I regretfully suspect that you may be

I support your recommendation, Mr. Chairman.

Governor Mullins.




MR. MULLINS. I support the recommendation. I think we have
allowed the fed funds rate to come down gradually this fall and more
rapidly recently as market rates also have fallen more rapidly. We’ve
yet to see the full impact on M2. Still. M2 seems to be decelerating
a bit. And I think there’s ample room to continue at least this
marginal decline. It is true that I’ve only seen Don’s forecast
errors on one side, but there’s always the possibility that it will
turn around.
MR. KOHN. It has.



I support the recommendation.

CHAIRMAN GREENSPAN. Roger, do you have any remarks?
MR. GUFFEY. I would support your recommendation, Mr. Chairman. I would go one step further. however, given the background that we have reduced the fed funds rate by roughly 3 / 4 of a percentage point in a six-week period starting with October 2 9 and that hasn’t shown through yet. Another 1/4 point doesn’t bother me. but if we continue I do have a concern about overshooting and I also have a concern about moving the fed funds rate to the level of the discount rate or making the discount rate a penalty rate. I would feel a lot more comfortable about your recommendation if indeed I was assured that the Board would act rather promptly to reduce the discount rate and that only half of it, 1/4 point, would show through. CHAIRMAN GREENSPAN. I might just say technically--

MR. GUFFEY. I don’t see standing on ceremonies, which I
think Wayne Angel1 has brought forth in the distinction between the
Board and the FOMC. Now is the time to set policy and I’d like to see
it established here.
MR. ANGELL. Mr. Chairman, I would like to comment on the monetary policy question rather than the technical one that I spoke t o earlier. My position is just about exactly identical with Tom Melzer’s. We have quite a few more months of rather unpleasant news ahead of us. And if anyone is under the illusion that there are not going to be pressures to reduce the fed funds rate and the discount rate in January, and February. and March--. It seems to me that we have at least three more months of rather bad news because in spite of all the manifestations from looking at M2 I really believe that most of the members of the Committee are looking at the real economy. And there’s always a lag in regard to the information on the real economy. That’s why the Chairman was suggesting the problem in regard to our overshooting. Now, I hope that this time around. Tom. there will be the votes to make the rather dramatic move, which may have to be made if you look at the forward looking indicators--themoney stock, commodity prices, and the yield curve. We could find ourselves in a position where we have to tighten before we have any real evidence that the economy has recovered. And I think that’s going to be very difficult to do. S o . Mr. Chairman, I can go along with this, but my decided preference is to g o much slower than 75 basis points a quarter. And I mean 75 basis points a quarter. If we continue to do that. at some point we’re going to find out what the Foreign Desk warned u s about: the problem of the dollar. It’s almost as if there’s a willingness to walk us there and we’re going to find that we’re



going to be blindfolded: we’re going to walk in the dark and sometime we’re going to find it. And that frankly scares me. S o . I’m very uncomfortable voting to do what we’re doing. I do hope that the votes are going to be there when it is necessary and the time comes to tighten. CHAIRMAN GREENSPAN. I think that’s well said. This is not
the tough vote: the tough vote is on the other side of this.
MR. BLACK. And it’s on the other side where we’ve made our
mistakes every time throughout our history practically.
CHAIRMAN GREENSPAN. Well. let us remember one thing that we can be pleased about and that is that we’ve cut off the top of this [inflation bulge] very early on. In terms of looking at the real M2. we have not been confronted with this big [unintelligible]. In other words. essentially we’ve stabilized the growth in money supply to an extent that we haven’t seen in quite a long time. And hopefully we can continue doing that. We’re not going to get it [unintelligible] but we have kept it within our target guidelines now for a surprisingly long period of time. And I just hope we have the capability of doing that in the future. But I think what Wayne Angell has said is something we’d better be at least careful about. [Unintelligible] run this. It’s going to happen. If it turns out
that the Greenbook forecast is right. that would be terrific. But as
Mike said very early on, he thinks that the risks of that forecast are
asymmetric toward a worse outcome. And I think we’re all saying that
that’s what we’re responding to, but it may not turn out that way.
And we had better be prepared t o - ­
VICE CHAIRMAN CORRIGAN. Well, the last time we really had the problem that Governor Angell was talking about wasn’t in fact in 1987: it was in 1988. To use the soft landing analogy. Mike pointed out to us 15 months ago that we overshot the runway. And if you want to look for mea culpas, the mea culpas belong in 1988 and not 1987. And I think that’s the last time-MR. ANGELL. But, Jerry. my view is that in the last quarter
of 1986 everything really took off and we really ignored all those
events. Every money market watcher knew in March of 1987 what had
happened and market interest rates soared and soared twice as much as
what we did.
VICE CHAIRMAN CORRIGAN. And policy firmed and then firmed
further through the summer of 1987 and the stock market crash took it
down. And when we got into 1988 that is where the real problems were.

CHAIRMAN GREENSPAN. Are you saying we overdid it in 1988 on
the up side?
VICE CHAIRMAN CORRIGAN. and far enough. No, we didn’t go down soon enough

MR. HOSKINS. We didn’t have a recession then: it’s a lot
tougher when there’s a recession on.


- 44

SPEAKER(?). vote?

No, that's right.

CHAIRMAN GREENSPAN. Okay, can we put this directive to a
MR. KOHN. Norm, I would put 4 percent and 1 percent in the two blanks at the end. MR. ANGELL.

On line 21--. I'm sorry, I may be ahead.

MR. BERNARD. We also distributed changes for lines 17-20 and to take account of the new information on trade for October and the CPI for November. which we got this morning. MR. ANGELL. I think lines 21-23 as proposed risk the mistake
of our saying that the inflation is okay. Do I have the wrong one?
It is dated December 18th. It says "Consumer prices continue to
increase moderately." My view is that it would be better to say that
consumer prices are rising moderately as compared to the rather strong
rise that occurred in the first nine months of the year. I'm afraid
this will be interpreted as meaning that we think consumer prices
during 1990 have been okay.
MR. SYRON. Why don't we say consumer prices have improved
CHAIRMAN GREENSPAN. The trouble, unfortunately. is that the
ex-oil part also accelerated at some point, which gives some--. May I
request that the Committee leave with the chair the solution to this
MR. ANGELL. That's fine.

CHAIRMAN GREENSPAN. We have to get the right language.
MR. BERNARD. "In the implementation of policy for the immediate future, the Committee seeks to decrease slightly the existing degree of pressure on reserve positions, taking account of a possible change in the discount rate. Depending upon progress toward price stability. trends in economic activity, the behavior of the monetary aggregates. and developments in foreign exchange and domestic financial markets, slightly greater reserve restraint might or somewhat lesser reserve restraint would be acceptable in the intermeeting period. The contemplated reserve conditions are expected to be consistent with growth of M2 and M3 over the period from November through March at annual rates of about 4 and 1 percent. respectively." CHAIRMAN GREENSPAN. Will you call the roll?
Yes Yes Yes Yes Yes

Chairman Greenspan Vice Chairman Corrigan Governor Angel1 President Boehne President Boykin



President Hoskins Against my instincts but given
the collective weight of my colleagues and the promise that they’ll do
the right thing next year at the right time--Yes
MR. BOEHNE. Get it in writing.
Some of us take that personally! Yes Yes Yes Yes Yes

Governor Kelley Governor LaWare Governor Mullins Governor Seger President Stern

CHAIRMAN GREENSPAN. We’ll now adjourn to luncheon. Our next meeting is February 5 - 6 . END OF MEETING